£2toS" } COMMITTEE PRINT
PENSION TASK FORCE REPORT ON PUBLIC
EMPLOYEE RETIREMENT SYSTEMS
COMMITTEE ON EDUCATION AND LABOR
HOUSE OP REPRESENTATIVES
NINETY-FIFTH CONGRESS
SECOND SESSION
MARCH 15, 1978
Printed for the use of the Committee on Education and Labor
952d Sesns?onSS } COMMITTEE PRINT
PENSION TASK FORCE REPORT ON PUBLIC
EMPLOYEE RETIREMENT SYSTEMS
COMMITTEE ON EDUCATION AND LABOR
HOUSE OF REPRESENTATIVES
NINETY-FIFTH CONGRESS
SECOND SESSION
MARCH 15, 1978
Printed for the use of the Committee on Education and Labor
U.S. GOVERNMENT PRINTING OFFICE
74-365 WASHINGTON : 1978
For sale by the Superintendent of Documents, U.S. Government Printing Office
Washington, D.C. 20402
COMMITTEE ON EDUCATION AND LABOR
CARL D.
FRANK THOMPSON, Jr., New Jersey
JOHN EL DENT, Pennsylvania
JOHN BRADEMAS, Indiana
AUGUSTUS F. HAWKINS, California
WILLIAM D. FORD, Michigan
PHILLIP BURTON, California
JOSEPH M. GAYDOS, Pennsylvania
WILLIAM "BILL" CLAY, Missouri
MARIO BIAGGI, New York
IKE ANDREWS, North Carolina
MICHAEL T. BLOUIN, Iowa
ROBERT J. CORNELL, Wisconsin
PAUL SIMON, Illinois
EDWARD P. BEARD, Rhode Island
LEO C. ZEFERETTI, New York
GEORGE MILLER, California
RONALD M. MOTTL, Ohio
MICHAEL O. MYERS, Pennsylvania
AUSTIN J. MURPHY, Pennsylvania
JOSEPH A. LE FANTE, New Jersey
TED WEISS, New York
CEC HEFTEL, Hawaii
BALTASAR CORRADA, Puerto Rico
DALE E. KILDEE, Michigan
3, Kentucky, Chairman
ALBERT H. QUIE, Minnesota
JOHN M. ASHBROOK, Ohio
JOHN N. ERLENBORN, Illinois
RONALD A. SARASIN, Connecticut
JOHN BUCHANAN, Alabama
JAMES M. JEFFORDS, Vermont
LARRY PRESSLER, South Dakota
WILLIAM F. GOODLING, Pennsylvania
BUD SHUSTER, Pennsylvania
SHIRLEY N. PETTIS, California
CARL D. PURSELL, Michigan
MICKEY EDWARDS, Oklahoma
Subcommittee on Labor Standards
JOHN H. DENT,
PHILLIP BURTON, California
JOSEPH M. GAYDOS. Pennsylvania
WILLIAM "BILL" CLAY, Missouri
MARIO BIAGGI, New York
LEO C. ZEFERETTI, New York
MICHAEL O. MYERS, Pennsylvania
AUSTIN J. MURPHY, Pennsylvania
BALTASAR CORRADA, Puerto Rico
PAUL SIMON, Illinois
GEORGE MILLER, California
CARL D. PERKINS, Kentucky,
Ex O fficio
Pennsylvania, Chairman
JOHN N. ERLENBORN, Illinois
JOHN M. ASHBROOK, Ohio
RONALD A. SARASIN, Connecticut
MICKEY EDWARDS, Oklahoma
ALBERT H. QUIE, Minnesota
Ex Officio
en
TABLE OF CONTENTS
Page
Part I — Committee findings and conclusions 1
Part II — Federal law presently affecting public employee retirement
systems 7
14th Amendment — Due process 7
14th Amendment — Equal protection 13
11th Amendment 16
Bases of Federal jurisdiction 17
Civil Rights Act of 1964— Title VII 22
Age Discrimination in Employment Act 25
Securities acts 28
Internal Revenue Code 30
Social Security 35
Revenue sharing 36
Fair Labor Standards Act 37
Labor Management Relations Act 38
Comprehensive Employment and Training Act 39
Bankruptcy Act ' 39
Military Selective Service Act 40
Cost Accounting Standards Board 42
Part III — State laws applicable to public employee retirement systems 43
Part IV — Characteristics and operations of public employee retirement
systems 47
A. Introduction
Extensive studies made 47
PERS influence vast and diversity great 48
Technical note 49
Acknowledgment 49
B. PERS Universe — General characteristics
Number and membership 51
Defined benefit and defined contribution 53
Insured and noninsured 54
Contributory and noncontributory 54
Plans by jurisdiction 55
Administration and coverage categories 56
Single and multiple employer plans 58
Social Security coverage 58
Pension coverage not universal 59
C. PERS Administration, reporting, and disclosure
PERS development and consolidation 61
Public pension policy 63
Retirement system administration 65
Retirement system audits 69
Plan disclosure to participants 71
Internal Revenue Code qualification 77
Recordkeeping and other procedures 79
Summary and conclusions 79
D. PERS participation, vesting, portability, and plan termination
provisions
Participation (membership) requirements 83
Vesting and related requirements 87
Portability provisions 92
Risk of public pension benefit loss or reduction 95
Summary and conclusions 99
(in)
IV
Part IV— Continued
E. PER,S benefit structure and income replacement levels Page
Retirement age 103
Disability benefits 107
Pre-retirement death benefits 107
Post-retirement death benefits 108
Post-retirement cost-of-living adjustments 108
Retirement benefit formulas 109
Gross income replacement rates 115
Net income replacement rates 119
Summary and conclusions 126
F. PERS finances
Assets and income 129
Employee and employer contributions and benefit payments 135
Employee contribution rates 138
Source of employer contributions 139
G. PERS funding
Need for reserve funding 144
Present funding practices 150
Actuaries, actuarial valuations and assumptions 158
Current funding status of defined benefit plans 163
PERS unfunded accrued liability 163
"Quick Liability" as a measure of PERS funding 166
Reserve Ratio as a measure of PERS funding 168
Assets to benefit payments ratio as a measure of PERS funding 170
Comparison of public and private pension systems 172
Summary and conclusions 179
H: PERS fiduciary and investment practices
Disclosure 183
Awareness of legal provisions 184
Enforcement of plan provisions 185
Accounting, auditing, and actuarial standards 185
Corruption and dishonesty 186
Recordkeeping and claims procedures 187
Diligence 187
Plan assets and fiduciary responsibility 188
Local investments 190
Substantive standards 192
Management and investment limitations 194
Summary and conclusions 195
APPENDICES
I. Tabular results of the Pension Task Force survey of public employee Page
retirement systems 199
II. Pension Task Force survey questionnaire 301
III. Technical note on the Pension Task Force survey methodology 323
IV. Number and membership of public employee retirement systems ___ 325
V. Summary and analysis of the pension and retirement systems of
the 50 States and the District of Columbia 397
VI. The governmental pension and retirement system of the State of
Hawaii: Coverage, funding, financing and fiduciary standards.. 473
VII. State and local pension plans for the State of Illinois: Coverage,
funding, financing, and fiduciary standards 481
VIII. Governmental pension plans of the State of New York and the
city of New York: Coverage, funding, financing, and fiduciary
standards 585
IX. Interrelationship of retirement programs covering employees of
Federal agencies and instrumentalities 1 663
X. Letter (August 15, 1977) from Internal Revenue Service responding
to questions concerning the tax qualification of public employee
retirement systems 673
XI. Letter (October 7, 1977) from Internal Revenue Service responding
to questions concerning the tax status of Federal retirement
systems 677
XII. GAO Report of August 3, 1977: Federal retirement systems: Un-
recognized costs, inadequate funding, inconsistent benefits 689
XIII. Department of Labor bibliography (May 1977) : Public pension
plans 769
XIV. Twentieth Century Fund Report: Conflicts of Interest: State and
Local Pension Fund Asset Management, by Louis M. Kohlmeier_ 859
Digitized by the Internet Archive
in 2013
http://archive.org/details/pensioceOOunit
PART I— COMMITTEE FINDINGS AND CONCLUSIONS
Pursuant to section 3031 of Public Law 93-406, The Employee
Retirement Income Security Act of 1974 (ERISA), the Committee
on Education and Labor and the Subcommittee on Labor Standards
of the House of Representatives have undertaken a comprehensive
study of federal, state, and local public employee retirement systems.
Section 3031 of ERISA requires that:
The Committee on Education and Labor and the Committee
on Ways and Means of the House of Representatives and the
Committee on Finance and the Committee on Labor and Public
Welfare of the Senate shall study retirement plans established and
maintained or financed (directly or indirectly) by the Government
of the United States, by any State (including the District of
Columbia) or political subdivision thereof, or by any agency or
instrumentality of any of the foregoing. Such study shall include
an analysis of —
(1) the adequacy of existing levels of participation, vesting
and financing arrangements,
(2) existing fiduciary standards, and
(3) the necessity for Federal legislation and standards with
respect to such plans.
In determining whether any such plan is adequately financed,
each committee shall consider the necessity for minimum funding
standards, as well as the taxing power of the government main-
taining the plan.
The Congress, in 1974, excluded governmental retirement systems
from the major provisions of ERISA in order that additional informa-
tion might be obtained regarding whether a need exists for further
regulation of governmental plans. This report is intended to provide
information to the Congress in accordance with the ERISA mandate.
The information and conclusions in this report are based on exten-
sive research and investigations conducted by the Committee. Public
hearings relating to the retirement systems covering state and local
government employees and the need for federal standards regulating
such systems were conducted during 1975 in Washington, D.C.,
California, Connecticut, and Illinois. In addition, numerous meetings
were held with representatives of every element of the governmental
pension plan community. A comprehensive survey of governmental
plans was conducted, covering 96% of all public pension plan partici-
pants. Virtually every element of the design and operation of govern-
mental pension plans was explored in order to fully document the
universe of public plans and their characteristics. In addition, exten-
sive research was undertaken to identify and record the various federal,
state, and local laws affecting the design and maintenance of public
employee retirement systems.
On the basis of the facts and information which have been received
and studied, your Committee makes the following conclusions:
(1)
2
IN GENERAL
The universe of public employee retirement systems (PERS)
exerts a substantial influence on the economic, social, and political
fabric of the United States. The far reaching influence of the PERS
involves a fundamental national interest affecting the well-being and
security of millions of workers and their families, the operation of the
national economy, the revenues of the United States, and the relation-
ships between the federal government and state and local govern-
ments. Recent experience shows the growth in the size and scope of
the PERS to be rapid, substantial, and increasingly interstate. The
national securities and other capital formation markets are heavily
influenced by the investment of over $115 billion in assets that are
currently held by the public employee retirement systems of state
and local governments. The manner in which the assets of state and
local government retirement systems are invested in the future will
have a direct effect on the well-being and economic security of the 13
million current participants as well as the future participants in such
plans. The provisions and significance of the PERS have not been
fully comprehended by plan participants, plan officials, other govern-
ment officials, and taxpayers generally. As a result, the current
regulatory framework applicable to the PERS does not adequately
protect the vital national interests which are involved.
EXISTING FEDERAL REGULATION
A number of federal constitutional and statutory provisions affect
the PERS in a significant manner. In many instances the precise
impact that these laws have on governmental plans is not yet clear.
The most significant bod}r of federal law presently affecting the
PERS is found in sections 401 and 503 of the Internal Revenue Code
(IRC). However, the ambiguity of the IRC provisions as they relate
to the PERS and the inconsistent interpretation and enforcement by
the Internal Revenue Service of the non-discrimination and other plan
qualification requirements have created confusion and sharply limited
the protections such provisions offer to plan participants. The absence
of any single federal agency to coordinate the administration and en-
forcement of the various federal laws relating to retirement income has
precluded the development of a unified national policy with regard
to either public employees retirement systems or private pension plans.
EXISTING STATE REGULATION
The various state constitutional and statutory provisions relating
to state and local government retirement systems do not as a whole
provide a uniform and adequate means of protecting the interests
of plan participants in their retirement systems. Statutory provisions
directly relating to the establishment and operation of public employee
retirement systems are often non-existent. In cases where relevant
state laws do exist, they are often found to be ambiguous, thus creating
legal uncertainties which are seldom clarified by the courts. In those
instances in which state laws relating to governmental pension systems
have been judicially clarified, the courts have frequently interpreted
the statutory or constitutional provisions in a manner that renders
3
them far less protective of participant interests than might be antici-
pated from a plain reading of such laws. Generally, the states have
failed to establish (1) clear standards regulating the activities of plan
fiduciaries, and (2) effective remedies for plans and plan participants
when injury occurs as a result of abuse. The absence of a coherent
and uniform regulatory framework has resulted in generally ineffec-
tive communication of basic plan provisions, inadequate safeguard-
ing of plan assets and insufficient protection of participants' interests.
REPORTING AND DISCLOSURE OF PLAN PROVISIONS AND
FINANCIAL AND ACTUARIAL INFORMATION
Serious deficiencies exist among public employee retirement systems
at all levels of government regarding the extent to which important
information is reported and disclosed to plan participants, public
officials, and taxpayers. In many cases plan participants are not in-
formed of basic plan provisions or the amount of their vested benefits,
thus leading to unwarranted forfeitures of earned benefits. Public
employee retirement systems at all levels of government are not
operated in accordance with the generally accepted financial and ac-
counting procedures applicable to private pension plans and other
important financial enterprises. The potential for abuse is great due
to the lack of independent and external reviews of the operations of
many plans. There is an incomplete assessment of true pension costs
at all levels of government due to the lack of adequate actuarial val-
uations and standards. In general, the absence of uniform accounting,
auditing, and actuarial standards impeaches the credibility of the
current practices in these areas.
PARTICIPATION, VESTING AND OTHER BENEFIT
PROVISIONS, AND PLAN TERMINATIONS
Generally, the benefit levels and benefit provisions of public em-
ployee retirement systems compare favorably with those found under
private sector pension systems. For example, the plans covering only
a very small minority of all public employees fail to meet ERISA's
minimum participation and benefit accrual requirements. However,
70 percent of the plans, covering about one-fifth of all state and local
government employees, fail to meet ERISA's minimum vesting re-
quirements (as do the federal plans covering the uniformed services).
A majority of all public plans (including the Federal Civil Service Re-
tirement System) also fail to meet an ERISA-like minimum require-
ment that 5 percent interest be paid upon the return to a terminated
participant of all mandatory employee contributions. In like manner,
nearly all public pension plan participants lack ERISA's protection
against the forfeiture of the employer financed portion of vested bene-
fits upon the withdrawal of employee mandatory contributions. A
substantial number of public employees at the state and local level
could benefit from ERISA's provisions (1) requiring joint and sur-
vivor annuities, and (2) prohibiting restrictive "break-in-service"
rules. With regard to benefit levels, a small number of public pension
plans were found to violate the maximum benefit limitations of section
4
415 of the Internal Revenue Code. Plan terminations and insolvencies
are rarely found in the PERS. In the few instances in which plan ter-
minations and insolvencies have occurred, participants suffered tem-
porary, but no permanent, benefit losses.
FUNDING
In the vast majority of public employee retirement systems, plan
participants, plan sponsors, and the general public are kept in the dark
with regard to a realistic assessment of true pension costs. The high
degree of pension cost blindness which pervades the PERS is due to
the lack of actuarial valuations, the use of unrealistic actuarial
assumptions, and the general absence of actuarial standards. None-
theless, a significant minority of public plans appear to have accumu-
lated substantial pension reserves through the use of ERISA-hke
actuarial funding methods. However, the majority of public plans
are experiencing rising pension costs as a percentage of payroll clue
to the lack of actuarial funding practices. Approximately 17 percent
of governmental plans continue to use the discredited pay-as-you-go
financing approach to satisfy benefit obligations. Efforts should be
made to eliminate any incentives which may exist for public plans
to continue using such inappropriate financing methods. Efforts
should also be made to encourage the accumulation of pension reserves
through the use of actuarial funding methods.
Furthermore, adherence by governmental retirement systems to a
proper funding policy, in those plans in which such a policy exists, is
often hindered by the absence of a rational relationship between the
source and level of plan revenues and the funding needs of the plan.
Pension plan revenues may lack stability and predictability due to
the indeterminate amount of funds available from stipulated alloca-
tions of state insurance premium taxes, federal revenue sharing funds,
or limited special tax levies. Given the increasingly restricted revenues
for many public pension plans, there is a compelling need for uniform
actuarial measures, terminology, and standards to enable plan par-
ticipants, plan sponsors, and taxpayers to assess the present funding
status and future funding needs of their systems.
PLAN CONTROL AND FIDUCIARY RESPONSIBILITY
Control over the administration of state and local public employee
retirement systems, and the management and investment of public
plan assets, is frequently inadequate. Often, public plans are admin-
istered without the benefit of either statutory guidance or even
written plan documents, creating open opportunities for abuse. At the
other extreme, public pension plans may be enveloped in a maze of
laws leading to conflicts, confusion, and the inadequate allocation of
fiduciary responsibilities. The absence of a uniform standard of con-
duct applicable to plan fiduciaries inhibits the proper discharge by
fiduciaries of their responsibilities, thereby hindering the proper oper-
ation of public employee retirement systems. Past breakdowns in the
accountability of plan fiduciaries have led to favoritism and abuse in
benefit determinations, failure to disclose information vital to the
interests of plan participants, violations of the Internal Revenue
5
Code, and even pension plan insolvencies. There is presently no
uniform requirement that public pension plan fiduciaries manage and
invest pension plan assets prudently and for the exclusive benefit of
plan participants and beneficiaries or that such fiduciaries be held
responsible for any loss resulting from a breach of their fiduciary
duties. Because adequate safeguards have not been erected, conflicts
of interests in many instances have been permitted to ripen into
clear examples of fiduciary abuse, with resultant losses of pension
plan assets and income. Additionally, the investment of public pen-
sion funds in securities issued by state and local governments is, in
most cases, inappropriate in light of the low-yielding, non-taxable
nature of such securities and the tax-exempt nature of governmental
plans. Because the investment of public pension funds in state and
local government securities is fraught with conflict and great potential
for the impairment of pension plan stability, it may be appropriate
in such circumstances to limit such investments. Numerous restrictive
investment practices imposed by statute or policy have also served
to impair public pension plan investment leturns. Clearly, a uniform
standard of fiduciary conduct is needed to conform public employee
retirement system administrative and investment practices with the
practices expected of other important financial enterprises.
PART II— FEDERAL LAW PRESENTLY AFFECTING PERS
In consideration of the need for federal legislation directly regulating
state and local governmental retirement systems, it is frequently
overlooked that a large number of federal laws presently regulate
various aspects of public employee retirement systems. An under-
standing of this existing federal regulation is vital to an appreciation
of whether additional federal legislation is needed in this area, and if
so, what course such legislation should take in relation to the existing
law. This Part of the Report is intended to provide an overview of the
present regulatory environment. As discussed below, the present
impact of various federal laws on governmental plans is in many
instances still in its formative stages. As awareness of the existing
federal regulation grows, and the enforcement of these various federal
laws is improved, it is clear that the federal laws already in existence
will have an increasingly greater influence on the design and operation
of state and local government pension plans.
FOURTEENTH AMENDMENT — DUE PROCESS
The Due Process Clause of the 14th Amendment1 is highly relevant
with regard to state and local public sector pension plans. That clause
provides that no state "shall deprive any person of life, liberty, or
property without due process of law".2 Its applicability to public plans
arises generally in two contexts: (1) attempts by a state or local
government to reduce the value of the entire accrued pension plan
package of a participant, and (2) denials of applications for benefits,
suspensions of benefits, and so on, by the plan without affording
minimal due process procedural guarantees to the affected plan
participant.
As a preliminary note, many cases which on their facts could involve
federal due process considerations are resolved in favor of the plan
participant on state constitutional or statutory grounds which relate
specifically to the retirement systems of the state, thereby obviating
the need for treatment of the due process aspects of the case. For
example, Sgaglione v. Levitt,3 discussed in detail infra, involves a New
York statute which purported to impair the value of plan participants'
benefits by removing the plan trustee's discretion regarding the
investment of a portion of the plan assets. As is apparent, an argument
could be made based on these facts that the state took something of
value from the plan participants without compensating them for that
taking — a prima facie due process violation. Because New York has a
constitutional provision which explicitly provides that benefits in any
state or local retirement system shall not be diminished or impaired,4
1 U.S. CONST, amend. XIV.
2 Id.
s 37 N. Y. 2d 507, 337 N.E. 2d 592 (1975) .
*N.Y. CONST, art. V, §7.
(7)
s
the New York court resolves the issue in Sgaglione in favor of the plan
participants without reaching any due process considerations.
Another example is found in Bakenhus v. City of Seattle.5 Bakenhus
was a police officer whose service commenced in 1925 when Seattle's
police pension plan provided for a benefit of 50% of the police officer's
salary during his last year of active service. In 1937, the Washington
legislature purported to amend the state retirement laws to provide
for a maximum benefit of $125 per month. Upon his retirement in
1950, Bakenhus discovered that the 1937 statutory enactment
represented a reduction in his pension benefit of $60 per month.
Despite the apparent due process issues involved, the Washington
Supreme Court found for Bakenhus on a combination of common law
contractural and equitable theories of recovery, never finding it
necessary to address the due process constitutional issues.
Before an aggrieved public plan participant can make an argument
that he has experienced a denial of due process, he must successfully
characterize his interest in his plan as a "property" interest.
Although there is clearly a trend towards the characterization of
public pension plan interests as "contractural" or "property" rights,
there remains a lingering notion that plan interests are more like a
gratuity from the employer than an enforceable obligation to the
participant. The only Supreme Court case on point, Pennie v. Reis,6
suggests that until every condition precedent to the actual payment
of benefits has been satisfied, the participant's interest in the fund
remains a "mere expectancy, created by the law, and liable to be
revoked or destroyed by the same authority." 7 As late as 1954, the
Pennsylvania Supreme Court noted that "there still lingers a remnant
of the ancient idea that a [public] pension is a manifestation of sover-
eign generosity." 8 In Creps v. Board of Firemen's Relief and Retirement
Fund Trustees of Amarillo 9 the Texas Court of Civil Appeals in 1970
approvingly restated 10 an earlier holding of the Texas Supreme Court
that "the rule that the right of a pensioner to receive monthly pay-
ments from the pension fund ... is subordinate to the right of the
legislature to abolish the pension system, or diminish the accrued
benefits of pensioners thereunder, is undoubtedly the sound rule to be
adopted."11 The Arkansas Supreme Court in 1973 noted that "techni-
cally, a pension constitutes a 'mere gratuity' subject to modification
or repeal as opposed to a vested right not subject to such
impairment." 12
Despite this authority, the trend is clearly towards viewing in-
terests in governmental plans as property or contractual interests,
thereby making them subject to the due process limitations of the
14th Amendment. In Hickey v. Pension Board,13 the Pennsylvania
Supreme Court noted that "the pension of today is not a grant of the
Republic nor in this case is it a gift of the City Fathers. It is the
product of mutual promises between the pensioning authority and
the pensioner. . . . " 14 and "The Legislature may strenghten the
* 48 Wash. 2d 895, 20f> P. 2d 530 (1956).
• 132 t;.S. 464.
i Id. at 471.
» Hickey v. Pennon Hoard of City of Pittsburgh, 378 Pa. 300, 304, 10G A. 2d 233, 235 (1954).
» 156 B.w. 2d 434 (Tex. Civ. App. l'J70).
W Id. at 437.
" City of Dallas v. Trammel, 120 Tex. 150, 158, 101 B.W. 2d 1000, 1013 (1937).
W Jones v. Cheney, 253 Ark. 020, 030, 480 S.W. 2d 784, 788 (1073).
" Supra, note 8.
i« Supra, note 8 at 305, 100 A. 2d at 235.
9
actuarial fibers but it cannot break the bonds of contractural obli-
gations. The permissible changes, amendments, and alterations
provided for by the Legislature can apply only to conditions in the
future, and never to the past." 15 The Washington Supreme Court
in Bakenhus v. City of Seattle states: "In this state, a pension granted
to a public employee is not a gratuity but is deferred compensation
for services rendered. . . . ", and refers to the city's obligation to
pay the pension as being of a "contractual nature." 16
Despite an acknowledgement that a public pension constitutes
a mere gratuity, the Arkansas Supreme Court in 1973 states: "The
retirement pay received by a retired employee . . . under a system
based on voluntary contributions of that employee, represents delayed
compensation for services rendered in the past due under a con-
tractural obligation inuring to his benefit, and is not a gratuitous
allowance in which the pensioner has no vested right." 17 The New
Jersey Supreme Court in 1964 states: "We have no doubt that [public]
pension benefits are not a gratuity. . . . " 18 and that "We think
there is no profit in dealing in labels such as 'gratuity', 'compen-
sation', 'contract', and 'vested rights'. None fits precisely, and it
would be a mistake to choose one and be driven by that choice to
some inevitable consequence." 19 The New Jersey Court does go
on, however, to state that "the employee has a property interest in
an existing fund which the State could not simply confiscate." 20 In
Opinion of the Justices,21 the Massachusetts Supreme Court is faced
with a proposed state legislative revision of the state's retirement
plan in which compulsory contributions by government employees
would be raised from 5 percent to 7 percent without any increase in
the benefits to be paid. The Massachusetts court first looks to its
state constitutional provisions 22 and concludes that the participant's
interest in the plan involves a "contractural relationship" and not
a "gratuity".23 The court goes on to suggest that the interest is not
a contract under an "analysis according to Professor Williston's
canons", but rather "is best understood as meaning that the retire-
ment scheme has generated material expectations on the part of
employees and those expectations should in substance be respected." 24
Numerous other cases also demonstrate that under the modern, and
increasingly followed, view, interests in governmental benefit plans
are characterized as "property" or "contractural", rather than
"gratuitous" in nature.25
As suggested above,26 the tendency of courts to resolve cases involv-
ing due process issues on specific state constitutional or statutory
provisions relating directly to benefit plans rather than on the more
general due process clause of the Fourteenth Amendment has
i« Supra, note 8 at 309, 106 A. 2d at 237.
is Supra, note 5 at 698, 296 P. 2d at 538.
w Supra, note 12 at 930. 489 S.W. 2d at 787-88.
18 Spina v. Consolidated Police and Firemen's Pension Fund Commission, 41 N.J. 391, 402, 197 A. 2d
169, 175 (1964).
19 Id. at 401, 197 A. 2d at 174.
20 Id. at 402, 197 A. 2d at 175.
21 364 Mass. 847, 303 N.E. 2d 320 (Mass. 1973).
22 Mass. Gen. Law Ann., ch. 32, § 25(5).
23 Supra, note 21 at 860, 303 N.E. 2d at 327.
2* Supra, note 21 at 861, 303 N.E. 2d at 327-28.
25 See e.g. Yeazell v. Copins, 98 Ariz. 109, 402 P. 2d 541 (1965); Kern v. City of Long Beach, 29 Cal. 2d 848,
179 P. 2d 799 (1947).
2« Supra, p. 2.
10
resulted, in a very limited number of cases in which there has been a
resolution of the due process issues. Whether a plan interest is "prop-
process must be given participants in various situations (e.g. denial
of claims for benefits) are largely unresolved issues. The few decisions
that discuss these issues do provide some guidance nonetheless.
Siletti v. New York City Employees* Retirement System27 addresses
both of the due process issues just described. Plaintiff's application
for accident disability benefits was denied without plaintiff's having
had an opportunity to present evidence under oath, to have an
evidentiary hearing, and so on. The District Court first considered
whether plaintiff's interest in the disability plan was sufficiently a
property interest to merit due process protection. It concluded that
"the disability benefits at issue are entitlements created by statute
for the benefit of persons meeting the specified qualifications. The
Fourteenth Amendment's protection of property has been broadly read to
expand protection to such entitlements." 28 . The Court goes on to con-
sider what procedural safeguards Siletti must be afforded, and con-
cludes that a full adversary or trial type hearing is not required
because questions of credibility and veracity of witnesses are not
likely to be involved, and hence plaintiff has little to gain from cross-
examining witnesses, taking testimony under oath, and so on. Because
the defendant's denial of plaintiff's application apparently occurred
in a fair proceeding, the Court refuses to allow Siletti any of the
proceedings he sought.19
In Lowcher v. Beame*0 plaintiff sought to be awarded service-
connected disability status. Defendant's Medical Board twice
examined plaintiff, each time denying her request to be represented
by an attorney and to present witnesses, but allowing her to submit
her own medical records. Reports of a third examination, done
by a physician to whom plaintiff was referred by the Medical Board,
were denied to plaintiff.
The court never considers whether the nature of plaintiff's interest
is "property", but apparently assumes as much, for the court proceeds
directly to consider whether plaintiff was given satisfactory proce-
dural safeguards. Contrary to the conclusion in Siletti, the court here
finds that "Although not entitled to a full adversarial hearing, plain-
tiff was entitled to know the evidence before the Medical Board. The
right to be advised of the evidence upon which the Retirement System
makes its determination is implicit in procedures which afford due
process of law." 31
The New York Court of Appeals has twice, albeit briefly, addressed
these issues in recent years. In Meschino v. Lowery*2 the Court of
Appeals finds that an interest in a disability plan does require that
procedural safeguards be present, but it finds that the opportunity
to present documentary and oral testimony was sufficient.
In Balash v. New York City Employee's Retirement System,™ how-
" 401 F. Supp. 162 (S.D.N.Y. 1975).
" Id. at 167 (emphasis added).
» Id. at 167-68.
"405 P. 8upp. 1247 (S.D.N.Y. 1975).
»' Id. at 124'J.
" 31 N. Y. 2d 772, 200 N.E. 2d 825 (N.Y. 1972).
"34 N.Y. 2d 054, 311 N.E. 2d 649 (1971).
erty" for due process purposes
11
ever, the Court of Appeals appears to take a somewhat broader view
of what degree of procedural safeguards a plan participant must be
presented before his "property" (i.e. interest in benefit plan) is quan-
tified. Petitioner, a disability plan participant, was retired from his
active employee status and placed on ordinary disability, but
given no written notice of any reason for the proposed retirement
and no opportunity to present medical or other evidence to either the
medical panel or its parent Board of Trustees of the Retirement Sys-
tem. Nor was he presented with any medical reports regarding that
condition which led the medical panel to its conclusions regarding his
medical condition. Similarly, after his involuntary retirement, he was
not given any written statements of the reasons for the action. The
Court of Appeals, in finding for petitioner, states :
Petitioner should have been advised of the charges against him and the evi-
dence on which they were based, afforded meaningful opportunity to present
documentary or other evidence in his favor at least to the Board of Trustees, and
advised of the reasons for their determination . . . Due process does not require
that petitioner has been afforded a full-blown adversary hearing with the right
to cross-examine the psychiatrists whose reports formed the basis of the medical
panel's certification and the board's subsequent determination. He had, however,
the right to be informed of the substance of those reports and should have been
given an opportunity, at least before the Board of Trustees, to controvert the
conclusions they contained . . .**
Despite the limited number of cases discussing the due process
issue, a number of tentative conclusions may be drawn. It appears
that a participant's interest in his state or local governmental plan
is sufficiently an interest in "property" to trigger the safeguards
against deprivations contained in the Fourteenth Amendment. It also
appears that in most proceedings in which the nature of a participant's
benefit plan interest is adjudicated, the participant must be given
notice of the nature of the proceeding and the evidence upon which
the government expects to reach its conclusion, and afforded an
opportunity, not necessarily in person, to present evidence to the
officials adjudicating the participant's claim. A full adversarial pro-
ceeding in most instances, it appears, will not be required.
That interests in governmental pension and welfare plans are
receiving this treatment is not surprising, in light of recent Supreme
Court decisions which have taken a more and more expansive view
of what kinds of interests represent "liberty" and "property" for due
process purposes.35 Further refinement of the requirements involving
the degree of procedural due process that must be provided can be
expected as courts are presented with cases involving indigent plan
participants, illiterate plan participants, adjudications of complex
benefit formulas, selection of complicated retirement options, and
so on.
A closely related issue, involving both the due process clause of
the Fourteenth Amendment as well as the non-impairment of con-
tractual obligations clause of Article I,36 is to what degree a state
34 Id. at 656, N.E. 2d at 649.
« See, e.q., Goldberg v. Kelly, 397 U.S. 254 (1970).
34 U.S. CONST, art. I, § 10, cl. 1: "No State shall enter into any Treaty, Alliance, or Confederation; grant
Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make anything but gold and silver Coin
a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Lav, or Law imparing the Obligation
of Contracts, or grant any Title of Nobility."
74-365—78 2
12
may alter its benefit plan without thereby unconstitutionally either
taking property of plan participants or impairing its contracturai
obligations to plan participants. As might be expected, the issue has
yet to be fully resolved. But two state supreme courts in recent
years have addressed it in a manner that appears sound and likely
to be followed in future years.
In Allen v. City of Long Beach,37 the California Supreme Court
was presented with a charter amendment of Long Beach City which
substantially and retroactively reduced the benefit and other pension
entitlements oi' participants. Plan participants attacked the charter
amendment on the ground that it unconstitutionally impaired the
contracturai rights, in the form of interests in the pension plan,
which participants had attained.
The California Supreme Court agrees that the charter amendment
represented an unconstitutional impairment, and states:
An employee's vested contractual pension rights may be modified prior to re-
tirement for the purpose of keeping a pension system flexible to permit adjust-
ments in accord with changing conditions and at the same time maintain the
integrity of the system. . . Such modifications must be reasonable, and it is for the
courts to determine upon the facts of each case what constitutes a permissible
change. To be sustained as reasonable, alterations of employees' pension rights
must bear some material relation to the theory of a pension system and its success-
ful operation, and changes in a pension plan which result in disadvantage to
employees should be accompanied by comparable new advantages ... In the
present case it appears that . . . [the amendment] substantially decreases plain-
tiffs' pension rights without offering an}' commensurate advantages, and there is
no evidence or claim that the changes enacted bear any material relation to the
integrity or successful operation of the pension system. . . .88
This statement that modifications in the plan are permitted so long
as the net value of the participant's interest remains essentially un-
changed is restated by the Massachusetts Supreme Court in Opinion
of the Justices.39 The Massachusetts House of Representatives re-
quested an advisory opinion on a proposed increase in the partici-
pants' rate of contribution (from 5% of salary to 7% of salary) with no
increase in benefit or other plan provisions. The Massachusetts Court
considers the proposed change in light of the impairment of contract
clause, or, "what amounts to much the same thing," 40 the due process
clause of the Federal and state Constitutions, and concludes:
Legislation which would materially increase present members' contributions
without any increase of the allowances finally payable to those members or any
other adjustments carrying advantages to them, appears to be presumptively in-
valid— invalid, that is to say, unless saved by the reserved police powers . . . That
the maintenance of a retirement plan is heavily burdening a governmental unit
has not itself been permitted to serve as justification for a scaling down of benefits
figuring in the 'contract,' although no case presenting proof of a catastrophic
condition of the public finances has been put. . . .41
Thus it appears that no significant depreciation in the overall value
of a benefit package is permitted in those plans in which interests are
characterized as contractual in nature, with regard to past accruals of
present and retired participants and also with regard to future accruals
37 45 Cal. 2d 128, 287 P. 2d 705 (1955).
« Id. at 131, 287 P. 2d at 707.
" Supra, note 21.
<° .Supra, note 21 at 803, :},03 N.E. 2d at 320.
«> Supra, note 21 at 804, 303 N.E. 2d at 320.
13
of present plan participants. Of interest and potential importance are
the suggestions in both the California and Massachusetts opinions that
impairments of contractual rights might be permitted upon the oc-
currence of some " catastrophic conditions," 42 or if necessary "to the
functioning and integrity of the pension S3'stem." 43 Whether the kind
of fiscal difficulties experienced by numerous muncipalities in recent
years would approach the thresholds implied in these opinions is
problematic. In any event, it is clear that the due process clause of the
Fourteenth Amendment and the impairment of contracts clause of
Article I will remain of significance to public emplo3ree retirement
s}rstems.
Fourteenth Amendment — Equal Protection
Another constitutional issue involves mandatory retirement as an
element of pension plans sponsored by state and local government
employers, and the Equal Protection Clause of the Fourteenth Amend-
ment.1 The Equal Protection Clause requires that where a fundamental
right or a suspect classification is involved, the government must not
discriminate between classes of citizens unless there is a compelling
public interest in doing so; i.e., the classification must withstand strict
scrutiny.2 If neither a fundamental right nor a suspect classification is
involved, then a government, consonant with equal protection re-
quirements, ma}^ discriminate between classes of citizens if such
discrimination is predicated on a rational basis, rather than justified
by a compelling public interest.3
The Supreme Court in Massachusetts Board of Retirement v. Murgia 4
squarely addresses the equal protection issue in the context of a
state government's mandatory retirement polic3r. Massachusetts law
required that all state police officers must be retired upon attaining
age 50. 5 Murgia, a state police officer who was retired upon his 50th
birthday, alleged that this mandatory retirement policy denied him
equal protection of the law. The Supreme Court first decides that
"rationality is the proper standard by which to test whether com-
pulsory retirement at age 50 violates equal protection", and then
finds the Massachusetts classification meets this rationality standard.6
The Court goes on to state:
[S]trict scrutiny is not the proper test for determining whether the mandatory
retirement provision denies appellee equal protection. San Antonio Independent
School District v. Rodriguez, 411 U.S. 1, 16 (1973), reaffirmed that equal protection
analysis requires strict scrutiny of a legislative classification only when the
classification impermissibly interferes with a fundamental right or operates to
the peculiar disadvantage of a suspect class. Mandatory retirement at age 50
under the Massachusetts statute involves neither situation.
This court's decisions give no support to the proposition that a right of govern-
mental employment per se is fundamental . . . Accordingly, we have expressly
stated that a standard less than strict scrutiny "has consistently been anplied to
state legislation restricting the availability of employment opportunities*'.
« Supra, note 37 at 133, 287 P. 2d at 768.
1 U.S. CONST, amend. XIV.
2 San Antonio Independent School Dist. v. Rodriguez, 411 U.S. 1 (1973).
3 Dandridge v. Williams, 397 U.S. 471 (1970).
<427 U.S. 307 (1976).
« Mass. Gen. Laws. ch. 32 § 26(3) (a) (1966).
« Supra, note 4 at 312.
14
Nor does the class of uniformed state police officers over 50 constitute a suspect
class for purposes of equal protection analysis. Rodriguez observed that a suspect
class is one 1 saddled with such disabilities, or subjected to such a history of pur-
poseful unequal treatment, or regulated to such a position of political powerless-
ness as to command extraordinary protection from the majoritarian political
process." While the treatment of the aged in this Nation has not been wholly
free of discrimination, such persons, unlike, say, those who have been discrim-
inated against on the basis of race or national origin, have not experienced a
history of purposeful unequal treatment or been subjected to unique disabilities
on the basis of stereotyped characteristics not truly indicative of their abilities.
The class subject to the compulsory retirement feature of the Massachusetts
statute consists of uniformed state police officers over the age of 50. It cannot
be said to discriminate only against the elderly. Rather, it draws the line at a
certain age in middle life. But even old age does not define a "discrete and insular"
group, in need of "extraordinary protection from the majoritarian political
process." Instead, it marks a stage that each of us will reach if we live out our
normal span. Even if the statute could be said to impose a penalty upon a class
defined as the aged, it would not impose a distinction sufficiently akin to those
classifications that we have found suspect to call for strict judicial scrutiny.7
The Court then goes on to demonstrate how the Massachusetts
classification is a rational one.8
Murgia, then, clearly affirms that age discrimination by a govern-
ment, at least in the form of mandatory retirement, and probably
in any form, is to be tested for equal protection purposes against a
simple "rational" standard, rather than against a more trying "strict
scrutiny" or "compelling public interest" standard.
The Court has not, in cases following Murgia, withdrawn from
Murgia in any way. In conclusion, then, it may be said that federal
constitutional law does not significantly affect whether state and
local government retirement systems can discriminate on the basis
of age.9
An equal protection issue is also present in the growing number
of cases involving governmental pension and welfare plans in which
it is alleged that a governmental plan's treatment of women differ-
ently from men represents a differentiation between classes of citizens —
men and women — that is prohibited by the mandate of the 14th Amend-
ment that no state deny its citizens the equal protection of the law.
The Supreme Court has addressed this precise issue in recent years.
In Geduldig v. Aiello,10 the Court considers a disability insurance
program that excluded from coverage disabilities due to pregnancy
as well as a number of other medical conditions. It was contended
that the exclusion of pregnancy related disabilities violated the
Equal Protection Clause. In directly rejecting this contention, the
Supreme Court states that the exclusion of pregnancy-related dis-
abilities from the set of risks insured by California in its plan does not
represent the kind of invidious discrimination prohibited by the
Equal Protection Clause. So long as the disability program is
"rationally supportable", the Court holds, no equal protection viola-
tion exists.11
7 Supra, note 4 at 312-14. Footnotes omitted.
• Supra, note 4 at 315.
• liutcf. iiradley v. Vance, Civil Action No. 76-0085 (D.C. Cir. June 23, 1977), in which it is held that
mandatory retirement at age GO for foreign service personnel is not National and hence violates the Equal
Protection Clause.
'"417 U.S. 481 (1974.)
» Id. at 495.
15
The Court again addresses the issue of whether sex related distinc-
tions in plans represent discrimination on the basis of gender, albeit
not in an Equal Protection context, in General Electric Co. v. Gil-
bert,12 also discussed elsewhere in this report.13 The Court first notes
that Geduldig v. Aiello deals with a disability plan very similar to
the General Electric plan, and indicates that therefore the analysis
the Court made in Geduldig, to the effect that the exclusion of preg-
nancy from a disability plan that otherwise did not discriminate
against a definable class or group in terms of the overall risk protec-
tion afforded by the plan, would be ' 'quite relevant" in considering
the General Electric plan.14 As it held in Geduldig, the Supreme Court
in Gilbert finds the General Electric plan is not a pretext "designed
to effect an invidious discrimination against the members of one sex
or another."15 Nor is the distinction drawn in the G.E. plan, the Court
adds, a sex-based distinction which is neutral on its face but in reality
a subterfuge to accomplish a forbidden discrimination.
In terms of sex discrimination and the Equal Protection Clause
generally, the Court has not indicated with an}^ clarity whether sex
discrimination by a governmental entity must be justified by a "com-
pelling state interest" and subject to "strict scrutiny" or merely
reflect a "rational relationship to a legitimate governmental interest." 15
The Court appears to be headed towards a new, middle standard in
which sex based discrimination must serve "important governmental
objectives" and be "substantially related" to the achievement of those
objectives.17
The Equal Protection issue is obviously closely related to the Title
VII, sex discrimination, issue. Whether a state pension plan could
discriminate on the basis of sex in a manner which violates the Title
VII prohibitions but not the Equal Protection Clause is not clear.
Presumably Congress, in making state and local governments subject
to Title VII, intended to prohibit certain employer practices that
were not already prohibited by the Equal Protection Clause.18
The Supreme Court has agreed to review 19 City of Los Angeles v.
Manhart, discussed at length in this report's discussion of Title VII.
However, Manhart does not involve the Equal Protection Clause.
Plaintiff in that case has challenged the defendant's pension plan
practice only on the basis of Title VII.20 Thus it appears unlikely that
the Supreme Court in Manhart will clarify the relationship between
Title VII and the Equal Protection Clause in the context of sex dis-
crimination in a governmental employer's pension or welfare benefit
plans.
In declining to review Reilly v. Robertson,21 the Supreme Court22 over-
m 429 U.S. 125 (1976).
» Infra, P. 24.
" Supra, note 12 at 133.
" Supra, note 12 at 134, quoting Geduldig v. Aiello.
» See, e.g., Frontiero v. Richardson, 411 U.S. 677 (1973), and Reed v. Reed, 404 U.S. 71 (1971).
it Califano v. Goldfarb, 430 U.S. 199 (1977); Califano v. Webster, 430 U.S. 313 (1977); Craig v. Boren, 429
U.S. 190 (1976).
is Washington v. Davis, 426 U.S. 229 (1976).
» 46 U.S.L.W. 3214 (1977) (No. 76-1810).
20 Infra, p. 23.
21 56 Ind. Dec. 400, 360 N.E. 2d 171 (1977).
22 46 U.S.L.W. 3215 (1977).
16
looked an opportunity to address the Equal Protection Clause issue
absent in Manhart. Reilly involves the use of sex-based mortality tables
by the Indiana State Teachers' Retirement Fund and the differing
benefits received under the plan by similarly situated men and
women. In a suit brought by a woman annuitant in the plan, the
Indiana Supreme Court first concludes that for purposes of the federal
Equal Protection Clause the "fair and substantial relation" standard
is to be applied to the plan's use of sex-based mortality tables, and
that a "substantial distinction" and "manifestly unjust or unreason-
able" standard is to be used for purposes of the Indiana Constitu-
tion.23 It then proceeds to afhrm the trial court's conclusion "that it
was arbitrary and without rational basis for the fund to classify an-
nuitants by sex . . ." 24 and hence violative of both the federal and
state Equal Protection clauses. It is possible that the U.S. Supreme
Court refused to review the Indiana Supreme Court decision because
the Indiana equal protection provisions would control the result even
if the Indiana Court's treatment of the federal Equal Protection
Clause were erroneous.
In conclusion, the significance of the Equal Protection Clause of
the 14th Amendment in the context of governmental plans and sex
discrimination is far from clear. It does appear that the Equal Pro-
tection Clause permits a state or local government to discriminate on
the basis of gender only when such discrimination serves important
governmental objectives and is substantially related to the achieve-
ment of those objectives. The meaning of gender-based discrimina-
tion in pension and welfare plans, however, remains very uncertain, as
does the resolution of the issue of whether the sex based discrimination
prohibited by Title VII is identical to the discrimination prohibited
by the Equal Protection Clause.
Eleventh Amendment
The Eleventh Amendment to the Constitution 1 at present affects
public employee retirement systems to a slight extent. Enactment of
federal legislation regulating state and local governmental pension
plans would heighten its importance with regard to public plans.
The Eleventh Amendment until recently has been interpreted
generally to bar a United States District Court from awarding mone-
tary damages to be paid by the State.2 Suits in federal court against
state officials to obtain prospective relief are not prohibited.3 The
law is also clear that the applicability of the 11th Amendment im-
munity from suit turns on whether the state is the real party in in-
terest, even though it may not be named directly in the suit itself,4
and that an award of money damages cannot be disguised as some
sort of equitable restitution for the purpose of evading the juris-
dictional limitations of the 11th Amendment.5 Thus, until recently,
23 Supra, note 21 at -JO.') -06, 3f.O N.E. 2d at 174-75.
» Supra, note 21 at 407. 360 N.E. 2d at 176.
1 U.S. CONST, amend. XI: "The Judicial power of the United States shall not be construed to extend
to any suit in law or equity, commenced or prosecuted against one of the United States by Citizens of
another State, or by Citizens or Subjects of any Foreign State."
2 Ford Motor Co. v. Dep't of Treasury of Indiana, 323 U.S. 159 (1915).
3 Ex parte Young, 209 U.S. 123 (1908).
4 Supra, note 2.
* Edelrnan v. Jordan, 415 U.S. G51 (1974).
17
participants, assuming they satisfy other jurisdictional requirements,
could sue their state plan officials in federal court for breaches of
their duties under state law, and receive injunctive and other
prospective relief, but not money damages. Local governments do
not enjoy the benefits of the Eleventh Amendment.6
In Fitzpatrick v. Bitzer,7 the Supreme Court is faced with an
award of money damages (attorney's fees) to be paid by the state
retirement fund as part of the judgment that plaintiff, a plan partic-
ipant, received in his successful Title VII sex discrimination suit
against the state pension system.
The Court holds that the immunity from an award of money
damages which the state enjoys under the Eleventh Amendment is
limited by the enforcement authorization in the Fourteenth Amend-
ment, and hence the award of legal fees as part of a judgement based
on Title VII was within the jurisdiction of the district court.8
This holding is of considerable significance for purposes of any of
the various formulations of a PERISA. By enacting federal legisla-
tion regulating public employee retirement systems pursuant to the
Fourteenth Amendment, Congress can remove the immunity of
states from money damage awards by federal courts, thereby enabling
the retrospective aspects (e.g. compensation for fiduciary breach) of
any federal legislation to be litigated and enforced in federal court.
This result is highly desirable in that it permits the development of a
more unified and consistent interpretation of national law. It also
avoids the situation whereby an aggrieved plan participant might be
forced to turn to federal court for injunctive relief and then to state
court to receive money damages.
An interesting observation is made by Justice Stevens in his con-
currence, in which he states that the attenuated relationship between
the payment of attorney's fees by the state pension fund and the
state's funding obligation makes the Eleventh Amendment "defense"
in this case inapplicable, since the award would not be paid by the
state in reality, but by the plan.9 Whether the Court will in the future
focus more closely on the relationship between the plan and the state
government is unclear.
Bases of Federal Jurisdiction
As the prospect of federal legislation regulating public employee
retirement systems becomes more likely, it is necessary to carefully
consider those bases of jurisdiction for such regulation available to the
Congress.
The most obvious jurisdictional basis for Congressional regulation of
public employee retirement systems is the Commerce Clause power
found in Article I, section 8, clause 3 of the Constitution. Congress,
by that clause, is generalty given the power to regulate interstate
commerce. Over the years the meaning of interstate commerce has
expanded significantly. In a case involving provisions of the Civil
Rights Act of 1964, 1 the Supreme Court summarized the meaning of
"interstate commerce" for purposes of the Commerce Clause: "In
« Gilliam v. City of Omaha, 524 F. 2d 1013 (8th Cir. 1975); Fay v. Fitzgerald, 478 F. 2d 181 (2d Cir. 1973).
7 427 U.S. 445 (1976).
s Id. at 456.
9 Id. at 459-60.
i 42 U.S.C. § 2000a et seq. (1970).
18
short, the determinative test of the exercise of power by the Congress
under the Commerce Clause is simply whether the activity sought to be
regulated is 'commerce which concerns more states than one' and has a
real and substantial relation to the national interest."2 Given the
tremendous impact public employee retirement systems have on the
securities markets and the national economy, the frequent movement
between various states of public plan participants, and numerous other
factors all demonstrating that public employee retirement systems in-
volve more than the state in which the plan is located, it is clear that
public plans involve interstate commerce, and hence may be regulated
by Congress under its Commerce Clause power.
Recent court decisions, most prominently National League of
Cities v. Usery,3 make clear, however, that Congress' Commerce
Clause power is not unlimited.
At issue in National League of Cities were 1974 amendments 4 to the
Fair Labor Standards Act.5 These amendments purported to make state
and local governments subject to the minimum wage and overtime
provisions of the Fair Labor Standards Act, thereby directly and
significantly affecting the fiscal operations of state and local govern-
ments. The National League of Cities, joined by numerous state and
local governments, argued that the Congressional action under the
Commerce Clause power was unconstitutional because it improperly
intruded into basic state government functions, a power not given the
Congress but rather reserved to the states in the 10th Amendment.6
Despite its earlier affirmation of 1) Congressional extension of mini-
mum wage and overtime provisions to state hospitals, schools, and
institutions,7 and 2) Congressional limitation of state wage and salary
increases,8 and its unamended pronouncement many years earlier in
United States v. California 9 that "there is no such limitation upon the
plenary power [of Congress] to regulate commerce",10 the Supreme
Court agrees with appellants' contention and finds the Congressional
exercise unconstitutional.
The Court appears to focus on the relationship between the 10th
Amendment reservation to the states and the grant of power to the
Jbederal Government in the Commerce Clause. The majority opinion
first notes with approval the suggestion by Justice Marshall in note 7
in Fry v. United States that "The [10th] Amendment expressly de-
clares the constitutional policy that Congress may not exercise power
in a fashion that impairs the States' integrity or their ability to
function effectively in a federal system." 11 The Court then proceeds
to focus on the effect the FLSA amendments would have on the
states' ability to function under the burden of the minimum wage
and overtime provisions, stating that such extension "will imper-
missibly interfere with the integral governmental functions" 12 of
states and their political subdivisions.
2 Heart of Atlanta Motel, Inc., 379 U.S. 241, 255 (1901).
■426 U.S. 833 (197»>).
« Pub. L. No. 93-259, 88 Stat. 55 (1974).
» 29 U.S.C. 5 201 et seq. (1970).
• U.S. CONST, amend X: "Tho powers not delegated to the United States by the Consitution, nor
prohibited by it to the Stales, are reserved to the States respectively, or to the people."
7 Maryland v. Wirtz, 392 U.S. 183 (1968).
* Fry v. United States, 421 U.S. 542 (1975).
» 297 U.S. 175 (1936).
>° Id. at 185.
11 Supra, note 8.
»2 Supra, note 3 at 851.
19
In considering the FLSA amendments in light of the clarified
relationship between the 10th Amendment and the Commerce Clause,
the Court states: "This exercise of congressional authority does not
comport with the federal system of government embodied in the
Constitution. We hold that insofar as the challenged amendments
operate to directly displace the States' freedom to structure integral
operations in areas of traditional government functions, they are not
within the authority granted Congress by Art. I, § 8, cl. 3." 13
The Court, in short, holds that the tension between Congressional
power under the Commerce Clause and the reservation of power to
the states in the 10th Amendment must be resolved in favor of the
states when the Congressional exercise threatens the ability of the
states to function as sovereigns in the federal relationship.
A number of other aspects of National League of Cities should be
noted. The decision is an extremely close one. Only four Justices join
with Justice Rehnquist in the majority opinion, and one of them,
Justice Blackmun, in a concurring opinion expresses strong reser-
vations over portions of the Court's decision.
Also, courts considering 10th Amendment arguments have generally
given National League of Cities an extremely narrow interpretation,
refusing to find that various Congressional enactments such as the
Equal Pay Act 14 and the Age Discrimination in Employment Act 15
impose sufficient burdens on state governments to threaten the state
and local governments' ability to function, the finding required for
Congressional actions based on the Commerce Clause to exceed the
limitation placed on that power by the 10th Amendment.16
With regard to Congressional enactment of a Public Emploj^ee
Retirement Income Security Act (PERIS A) based on Commerce
Clause jurisdiction, it appears that only a full, immediate funding
requirement would even begin to affect the fiscal or other operations
of state and local governments in a manner which might threaten the
viability of a state to continue as a sovereign. Clearly federal legisla-
tion limited to such items as reporting, disclosure, and fiduciary re-
sponsibility would produce a very slight cost impact in terms of com-
pliance by state and local governments. In fact, a net reduction in cost
might be achieved as existing asset management and investment
techniques were replaced with federally mandated practices that
produced greater income, more efficient management techniques, and
so on. Even federal vesting requirements, in the absence of strict
funding standards, would probably not reach the level of intrusion in
basic state functions which the Supreme Court found in League of
Cities. Further, it is conceivable that legislation mandating a relatively
long-term funding requirement (e.g. forty years to fund past service
liabilities) would be permissible under Commerce Clause jurisdiction.
As will be discussed, infra, given the ability of Congress to act pursuant
» Supra, note 3 at 852.
"29 TJ.S.C. § 206(d) (1970).
is 29 TJ.S.C. § 621 et seq. (1970).
16 See, '.g., Usery v. Bd. of Educ. of Salt Lake City, 421 F. Supp. 718 (D. Utah 1976); Usery v. Bettendorf
Community School Dist., 423 F. Supp. 637 (S.D. Iowa 1976); Christensen v. Iowa, 417 F. Supp. 423 (N.D.
Iowa 1976); Usery v. Allegheny County Inst. Dist. 544 F. 2d 148 (3d Cir. 1976), cert, denied, 45 U.S.L.W. 3651
(1977) ; Usery v. Charlestown County School Sys., No. 76-2340 (4th Cir. July 25, 1977) ; Usery v. Fort Madison
School Dist., No. C 75-61-1 (S.D. Iowa, motion to dismiss denied Sept. 1, 1976); Usery v. Sioux City Com-
munity School Dist., No. C 76-4024 (N.D. Iowa, motion to dismiss denied Aug. 20, 1976); Riley v. Univ. of
Lowell, Civ. No. 76-2118-M (D. Mass., motion to dismiss denied July 22, 1976).
20
to its power under the 14th Amendment, the issue of limited Commerce
Clause power, for purposes of federal regulation of state and local
pension sy stems, is largely academic.
In conclusion, it appears that Congressional power to enact legisla-
tion, including some sort of a "PERISA", pursuant to the Commerce
Clause is limited by the 10th Amendment only when the Congressional
enactment so vitally affects a basic state or local government function
that the capacity of the state to function as a sovereign in the federal
relationship is severely threatened.
A second source of federal jurisdiction, admittedly cumbersome
and indirect, by which the federal government can constitutionally
regulate public employee retirement systems, involves the federal
taxing power.
Congress clearly has the authorit}^ to tax income.17 It is equally
clear that Congress may grant certain deductions and exemptions
from such income tax,18 and that "Whether and to what extent
deductions shall be allowed depends upon legislative grace; and only
as there is clear provision therefore can any particular deduction be
allowed." 19
Congress could currently impute to participants in governmental
plans the value of their vested and funded interests in such plans, as
well as the income generated by such interests. It could then condition
a deferral, deduction, or exemption to currently recognizing that
income upon the satisfaction by the plan of various conditions. Such
a methodology would obviously generate tremendous pressure by
plan participants on public plans to comply with whatever federal
conditions must be met to gain favorable tax treatment for the par-
ticipants.
The disadvantages of this kind of regulation are apparent. The
regulation is not of the plan directly; it relies on the desire of plan
participants to receive favorable tax treatment to force plan sponsors
and administrators to satisfy whatever conditions must be satisfied in
order to receive beneficial tax treatment. It is cumbersome in that the
federal government does not mandate that governmental plans must
meet specified standards, but rather relies on a permissive, conditional,
tax exemption or deferral over which it has no direct control to achieve
the desired standards in governmental plans. The government's pri-
mary concern would be to enforce the tax law; achievement of socially
desirable plan operations and provisions would be a secondar}^ con-
cern. Finally, plan participants would be excluded from the regula-
tory process in that the relationship, as in most tax matters, would
be exclusively between the taxpayer (the plan) and the Internal
Revenue Service.
These disadvantages notwithstanding, the taxing power represents
a basis for federal regulation of public employee retirement systems
which completely avoids any limitations on Congressional jurisdiction
imposed by the 10th Amendment.
A third, and extremely effective, source of power through which
Congress can fully regulate public employee retirement systems is
found in the Fourteenth Amendment of the Constitution. That amend-
ment states:
J? U.S. CONST, amend X\T.
ii LenMn v. District of Columbia, 461 P. 2d 1615 (D.C Cir. kjt.1).
" New Colonial lec Co. v. Helvoring, 6'J2 U.S. 435, 440 (1934).
21
Section 1. All persons born or naturalized in the United States, and subject to
the jurisdiction thereof, are citizens of the United States and of the State wherein
they reside. No State shall make or enforce any law which shall abridge the
privileges or immunities of citizens of the United States; nor shall any State
deprive any person of life, liberty, or property, without due process of law; nor
deny to any person within its jurisdiction the equal protection of the laws ....
Section 5. The Congress shall have power to enforce, by appropriate legislation,
the provisions of this article.20
By finding that the rights to be protected by a Public Employee
Retirement Income Security Act are property rights, or rights in the
nature of liberty, or that the purpose of the legislation is to afford
citizens equal protection of the laws, Congress can enact PERISA
legislation pursuant to section 5 of the 14th Amendment rather than
pursuant to the Commerce Clause power.
Recent judicial decisions support this methodology as a means of
avoiding the limitation placed on Congressional power by National
League of Cities.
In South Carolina v. Katzenbach,21 the Court was faced with the
argument that the Voting Rights Act of 1965 22 was unconstitutional
in that it improperly purported to be enacted pursuant to the power
given Congress in the identical enforcement authorization of the
15th Amendment. In considering whether Congressional action is
appropriate under the enabling sections of constitutional amendments,
the Court states: "As against the reserved powers of the States,
Congress may use any rational means to effectuate the constititional
prohibition. . . 23
A number of recent Court decisions 24 support the theory that the
constitutional prohibitions addressed in section 1 of Amendment XIV
which can be addressed by Congress legislatively pursuant to section
5 go well beyond the race oriented injustices prominent at the time
the 14th Amendment was enacted and ratified.
Arbitrary treatment of citizens, disparate treatment of various
classes of citizens, and the deprivation of rights that are in the nature
of property or interests that are in the nature of liberty are all among
the Constitutional prohibitions contained in section 1 of the 14th
Amendment and among the prohibitions which Congress is empowered
to address legislatively in section 5 of that amendment. Clearly any
PERISA legislation would directly affect each of these prohibitions.
The repeated willingness of the Supreme Court 25 to apply the
prohibitions of section 1 to events, conditions, and processes never
contemplated by Congress when it enacted the 14th Amendment in
1868 strongly supports the notion that section 5 gives Congress the
power to address those .concerns through legislation.
Moreover, it is increasingly clear that Congress can affect integral
functions of state and local governments pursuant to its power under
section 5 of the 14th Amendment even though such legislation may
20 U.S. CONST, amend. XIV.
W 383 U.S. 301 (1966).
22 42 U.S. C. § 1971, 1973 et seq. (1970).
23 Supra, note 21 at 324.
2< See e.g., Usery v. Board of Education of Salt Lake City, 461 F. Supp. 718 (D. Utah 1976): Usery v.
Bettendorf Community School Dist.. 423 F. Supp. 637 (S.D. Iowa 1976); Usery v. Allegheny County Inst.
Disk, 541 F. 2d 148 (3d Cir. 1976); Usery v. Meyer Memorial Hosp., 428 F. Supp. 1368 ( .D.N.Y. 1977).
25 Sec e.g.. Perry v. Sindermann; 408 U.S. 593 (1972) in which a strong expectation of continued employ-
ment is held to involve a property right, and Goldberg v. Kelly, 397 U.S. 254 (1970), in which it is suggested
that welfare entitlements are a form of property.
22
be beyond the power granted to Congress under the Commerce
Clause. National League oj Cities v. Usery 26 itself explicitly refrains
from addressing this issue. But only four days after deciding National
League oj Cities, the Supreme Court in Fitzpatrick v. Bitzer 27 (also
written by Justice Rehnquist), in recognizing that the 1972 amend-
ments to Title VII of the Civil Rights Act of 1964 are enacted pursuant
to section 5 of the 14th Amendment, states: "We think that Congress
may, in determining what is 'appropriate legislation'' for the purpose
of enforcing the provisions of the Fourteenth Amendment, provide
for . . . [measures] which are constititionalry impermissible in other
contexts." 28 Thus federal legislation that is beyond one federal
jurisdictional basis (the Commerce Clause), may nonetheless come
within another federal jurisdictional basis (the enforcement section
of the 14th Amendment), to accomplish what was prohibited by the
11th Amendment.29 There is no reason to believe that in enacting a
PERISA Congress could not use section 5 of the 14th Amendment to
accomplish what might be prohibited by the 10th Amendment.
If the National League of Cities decision does in some manner
limit the kind of regulation of state and local government retirement
plans which Congress can legislate, the Fourteenth Amendment's
grant of enforcement power provides Congress with an alternative
jurisdictional basis that is ample to fully regulate the universe of
public employee retirement systems.
A fourth means by which Congress can effectively regulate govern-
mental plans involves the placing of additional conditions onto
federal revenue sharing grants made to state and local governments.
Certain conditions relating to the use by local governments of
revenue sharing funds have existed in the past, and others continue
to exist today.30 For instance, local and state governments receiving
funds must be audited independently every three years in accordance
with generally accepted accounting principles,31 and must publicize
proposed uses of revenue sharing funds.32 Although Congress has
been unwilling to attach conditions onto its revenue sharing grants,
it clearly could require that retirement systems of state and local
governments conform to specified standards as a condition to the
payment of revenue sharing funds to the governmental entity. Given
the huge sums involved in the revenue sharing program,33 and the
fact that revenue sharing funds are often used to fund state and
local government pension programs, attaching conditions to revenue
sharing grants represents an effective method by which the federal
government could induce state and local government plans to conform
their pension plans to meet certain standards.
Civil Rights Act of 1964 — Title VII
Federal law regulating employment practices significantly affects
the operation of state and local government pension plans. Section
*• Supra, note 3 at footnote 17.
* 427 U.S. 445 (1976).
2« Id. at 456.
» Supra, p. 16.
" Infra, p. 36.
« Act of Oct. 13, 1976, Pub. L. No. 94-488 (to be codified in 31 U.S.C. 1243(c)(1)).
" Act of Oct. 13, 1976, Pub. L. No. 94-188 (to be codified in 31 U.S.C. 1241(c)(1)).
« Approximately $6.9 billion of entitlement payments were authorized under the revenue sharing pro-
p-am for fiscal year 1977. S. Rep. No. 94-1207, 94th Cong., 2d Sess. 1-2, reprinted in 1976 U.S.C. C.A.N.
">151-52.
23
703(a) of the Civil Rights Act of 1964 1 provides that it shall be unlaw-
ful for an employer to discriminate against an employee in an employ-
ment practice on the basis of race, religion, sex, or national origin.
The 1964 Act was amended in 1972 2 to bring state and local govern-
ments, as employers, within the scope of employers subject to the Act.
It is undisputed that a government's administration of its retire-
ment system represents an employment practice within the meaning
of Title VII.3 Accordingly, it is clear that a retirement system may
not discriminate on the basis of the sex of a plan participant. But
what constitutes unlawful discrimination on the basis of sex, in the
context of a retirement system, is far from clear.
The Supreme Court, in Fitzpatrick v. Bitzer* recently considered
only 11th Amendment issues, and affirmed lower court decisions
holding that it is an unlawful employment practice for an employer
to maintain a retirement system that allows women to retire earlier
than men and that provides higher rate differentials for women who
elect early retirement. The trial court stated: "A plain reading of the
present statute [Title VII] teaches us that retirement plans which
treat men and women differently with respect to their ages of retire-
ment are prohibited.' ' 5 The District Court attempted to decisively
resolve the sex discrimination issue: "The Connecticut retirement plan
constitutes an unlawful employment practice, because it discrimi-
nates between men and women with regard to employment fringe
benefits and is therefore found by the Court to be illegal and in viola-
tion of federal statutory law." 6
Other appellate court cases appear to strongly support this inter-
pretation of Title VII as it applies to retirement systems generally.
Bartmess v. Drewrys U.S.A., Inc.,7 and Peters v. Missouri Pacific Rail-
road Co.8 find violative of section 703(a) a collectively-bargained retire-
ment plan that mandates retirement for women at age 62 and for men
at age 65. Rosen v. Public Service Electric and Gas Co.9 holds that a
retirement plan which pays women who elect early retirement a higher
benefit than similarly situated men to elect early retirement, and
which mandates that women retire at age 65 and men at age 70, vio-
lates Title VII. In Chastang v. Flynn and Emrich Co.,10 the Fourth
Circuit affirms the district court's holding that a vesting schedule which
results in female early retirees' retaining a higher percentage of vesting
than similarly situated male early retirees represents prohibited dis-
crimination on the basis of sex.
The issues involved in these appellate court cases, together with an
additional important issue, are present in Manhart v. City of Los
Angeles, Department oj Water.11 Manhart involves a contributory define
benefit pension plan maintained by the Department of Water and
Power, City of Los Angeles. Under the Department's plan, men and
women similarly situated received equal retirement benefits. But using
1 42 U.S.C. § 2000e-2(a)(1970).
2 Equal Employment Opportunity Act of 1972, Pub. L. No. 92-261, 86 Stat. 103 (1972).
» Fitzpatrick v. Bitzer, 427 U.S. 445 (1976).
* Id.
6 390 F. Supp. 278, 287 (D. Conn. 1974); see also, Peters v. Missouri Pac. R.R. Co., 483 F. 2d 490 (5th Cir.
1973), cert, denied, 414 U.S. 1002 (1973).
• Id. at 288.
» 444 F. 2d 1186 (7th Cir. 1971), cert, denied, 404 U.S. 939 (1971).
8 483 F. 2d 490 (5th Cir. 1973), cert, denied, 414 U.S. 1002 (1973).
9 477 F. 2d 90 (3d Cir. 1973).
» 541 F. 2d 1040 (4th Cir. 1976).
11 553 F. 2d 581 (9th Cir. 1976). rehearing and rehearing en banc denied, 553 F. 2d 592 (1977); cert, granted,
46 U.S.L.W. 3214 (1977) (No. 1810).
24
the rationale that women as a group live longer than men, the plan
required a 15 percent higher contribution by the female participants.
Hence a women participant contributed more than a male participant,
yet both received the same benefit.
In striking down this aspect of the pension plan, the Court of
Appeals states:
To require every individual woman to contribute 15 percent more into the
retirement fund than her male counterpart must contribute because women "on
the average" live longer than men is just the kind of abstract generalization,
applied to individual women because of their being women, which Title VII was
designed to abolish. Not all women live longer than all men, yet each individual
women is required to contribute more, not because she as an individual will live
longer, but because the members of her sexual group, on the average, live longer.12
The issue in Manhart regarding whether equal benefits as well as
equal contributions are required is reflected in the relevant admin-
istrative actions occurring in this period. An E.E.O.C. guideline of
1972 states: "It shall be an unlawful employment practice for an
employer to have a pension or retirement plan which establishes
different optional or compulsory retirement ages based on sex, or
which differentiates in benefits on the basis of sex." 13 The same
E.E.O.C. regulation deems it violative of the law for a plan to pay
unequal benefits to males and females even if employer contributions
are equal. On the other hand, regulations issued by the Department
of Labor 14 under the Equal Pay Act are to the contrary, and permit
unequal benefits so long as employer contributions are equal.
Were the case law to end at this point, the meaning of Title VII in
the context of retirement plans generally, and governmental retirement
systems specifically, could be viewed as taking shape in a consistent,
albeit slow, and, in terms of the specific kinds of discrimination raised,
somewhat unpredictable manner.
The Supreme Court's recent decision in General Electric Co. v.
Gilbert,™ however, significantly clouds this entire interpretive process.
The facts and holding of Gilbert are well-known and are accordingly
not discussed here. The significance of Gilbert is impossible to
predict, both in terms of Title VII law generally and sex discrimina-
tion in employer-sponsored retirement plans specifically. Clearly,
some employment practices that formerly were believed to be pro-
hibited because discrimination on the basis of sex was involved are
now permitted. For example, the Supreme Court in Nashville Gas
Co. v. Satty 16 held an employer's policy of forfeiting an employee's
seniority following her pregnancy leave violates Title VII, but that
the employer's practice of not awarding sick-leave pay to pregnant
employees is not a per se violation of the Act. Whether any of the
discriminatory pension plan practices struck down in Rosen v. Public
Service Electric and Gas Co.,17 Chastang v. Flynn and Emrich Co.,18
Bartmess v. Drewrys U.S.A., Inc.,19 or Peters v. Missouri Pacific Pail-
road Co.,20 are permitted remains to be seen. The 9th Circuit Court of
12 Id. at 585.
a 29 CP JR. § 1G04.9 (1970).
«29 C.F.R. §800.110 (1970).
>5 429 U.S. 12.") (1970).
i«46 U.S.L.W. 4200 (1977).
>7 Supra, note 9.
•8 Supra, note 10.
'» 444 P. 2d 1180 (7th Cir. 1971), cert, denied, 404 U.S. 939 (1971).
20 Supra, note 8.
25
Appeals, in affirming its pre-Gilbert decision in Manhart v. City of Los
Angeles Department oj Water,21 concludes that the illegality of the prac-
tice of the Los Angeles Department of Water and Power in requiring a
15 percent higher contribution from female participants is not made
permissible by the Supreme Court's decision in Gilbert. Importantly,
however one of the three judges who issued the original 9th Circuit
opinion and considered the petition for rehearing states very strongly
in a dissent to the denial of the motion for a rehearing that appellants
(City of Los Angeles) , because of Gilbert, should have at least had the
opportunity to prove that its retirement plan was justified. Further,
Judge Kilkenny continues in dissent, the sex discrimination aspects of
the Los Angeles plan are exactly analogous to those aspects of General
Electric's disability plan, and hence should be permitted in light of
Gilbert/2
While the 9th Circuit Court concluded that the Supreme Court's
decision in Gilbert does not make legitimate the Los Angeles Water
Department plan, Judge Kilkenny's dissent signifies that Gilbert will
alter the analysis of retirement plans that has developed over the
years in the context of Title VII.23 The precise way in which this
developing regulatory and case law will change remains to be seen.
The Supreme Court has granted certiorari in Manhart,24' and its
treatment of the appeal may resolve many of the issues sharply dis-
puted by Judge Kilkenny as well as the broader issues relating to the
use of gender based mortality tables.
Legislative efforts presently underway to reverse Gilbert will, if
successful, clarify that the kind of coverage in the General Electric
disability plan represents the kind of discrimination on the basis of
sex prohibited by Title VII.25 It is not expected that these pending
legislative proposals will address the variety of practices described in
Bartmess v. Drewrys U.S.A., Inc., Peters v. Missouri Pacific R.R. Co.,
Rosen v. Public Service Electric and Gas Co., and Chastang v. I'lynn and
Emrich Co.26
Government plans, in any event, will clearly remain subject to Title
VII, and thereby subject to a pervasive and significant from of federal
regulation.
Age Discrimination in Employment Act
The Age Discrimination in Employment Act 1 respresents an addi-
tional aspect of federal law that has a significant impact on state and
local public employee retirement systems.
The Act, as passed in 1967, prohibits emplo}^ers from discriminating
against individuals on the basis of age with respect to hire, discharge,
or other terms and conditions of employment, 2 if those individuals
are between the ages of 40 and 65.3 Exceptions from the general pro-
scription against discrimination on the basis of age include the
well known bona fide occupational qualification situation,4 bona fide
21 Supra, note 11.
22 Ii. at 594.
« See, e.g., Mitchell v. Bd. of Trustees of Pickens County School Dist., Civ. No. 75-143 (D.S.C. July 27,
1977).
24 Supra, note 11.
25 S: 995. 95th Cong. 1st Sess. (1977); H.R. 6075, 95th Cong. 1st. Sess. (1977);
26 Supra, notes 17-20.
1 29 U.S. C. § 621-834 (1979).
2 Id. § 623.
* Id. § 631.
« Id. §623(0(1).
26
seniority system or employee benefit plan exceptions,5 and the good
cause exception.6
The 1967 Act specifically excluded all federal, state, and local govern-
ment entities from the definition of employer.7 For state and local
governments, the key Act is the 1974 Act amending the A.D.E.A.8
State and local governments were specifically brought within the
definition of "employer",9 and hence are treated equally with private
employers under the Act.10 The prohibited employer practices, as well
as the exceptions permitted in section 623(f), were not altered by the
1974 amendments.
Notice must also be taken of pending amendments to the Age
Discrimination in Employment Act, H.R. 5383, as passed by the House
of Representatives on September 23, 1977, would (1) raise the upper
limit of the protected age group for private sector and state and local
government employees from age 65 to 70, and, most important for
present purposes, (2) clarify that involuntary retirement before
age 70 on account of age shall not be required or permitted by any
seniority system or employee benefit plan.11 The Senate passed H.R.
5383 on October 19, 1977, but exempted from the prohibition against
involuntary retirement at age 65 executives entitled to large pension
benefits and fully tenured college and university professors. As is
immediately apparent, the enactment of H.K. 5383 would significantly
alter the A.D.E.A. as it relates to public employee retirement systems.
The Age Discrimination in Employment Act, it is recalled, does per-
mit an employer, including a governmental employer, to require an
employee to retire, or otherwise discriminate against an employee
because of age, if the employer does so
To observe the terms of a bona fide seniority system or any bona fide employee
benefit plan such as a retirement, pension, or insurance plan, which is not a sub-
terfuge to evade the purposes of this chapter, except that no such employee
benefit plan shall excuse the failure to hire any individual. . . .12
A quick reading of this provision demonstrates its inherently con-
tradictory nature: an employer may not discriminate on the basis of
age unless the employer maintains a bona fide pension plan which
permits or requires discrimination on the basis of age. As might be
expected, the meaning of 29 U.S.C.A. 623(f)(2), better known as the
"4(f)(2) exception",13 has not been clear to the courts either.
The varying analyses that have surfaced with regard to the 4(f)(2)
exception have been substantially clarified in recent months. In
McMann v. United Air Lines, 14 the Supreme Court holds that a
•Id. § 632(0(2).
• Id. § 623(0(3).
7 Id. § 630(b).
« A.D.E.A. Amendments of 1974, Pub. L. No. 93-259, 88 Stat. 74.
» 29 U.S.C. § 630(b) (Supp. V 1975).
10 This section does not include a discussion of the application of the A.D.E.A. to the Federal Government
as an employer of. Christie v. Marston, 551 F. 2d 1080 (7th Cir. 1977).
•i H.R. Rep. No. 527 Part 1, 95th Cong., 1st Sess. (1977).
M Supra, note 5 (emphasis addedl.
W 2'j U.S.C. § 623(f) (2) (1970) (corresponds to Age Discrimination in Employment Act of 1967, section 4(f)
(2)).
i« 46 U.S.L.W. 4013 (1977).
27
retirement plan which antedates the enactment of the A.D.E.A. in
1967 and requires retirement prior to age 65 is not prohibited by the
Act, but rather is permitted under the 4(f)(2) exception. The Court
extensively reviews the legislative history of section 4(f)(2), and
concludes that it was "intended to permit observance of the manda-
tory retirement terms of bona fide retirement plans, but that the
existence of such plans could not be used as an excuse not to hire any
person because of age." It also holds that "we find nothing to indi-
cate Congress intended wholesale invalidation of retirement plans
instituted in good faith before its passage, or intended to require
employers to bear the burden of showing a business or economic
purpose to justify bona fide pre-existing plans. . . ."15 This decision by
the High Court indicates that the analysis of the 5th Circuit Court of
Appeals in Brennan v. Taft Broadcasting Co., 16 in which a pre-1967
retirement plan requiring retirement at age 60 is found permissible,
is correct, thereby resolving the clear conflict that had previously
existed between the 4th and 5th Circuits with regard to the legality
of mandatory retirement policies established before 1967.
An alternative analysis that the Supreme Court has decided not to
consider is found in the 3d Circuit's opinion in Zinger v. Blanchette.17
The Court focuses not on whether the establishment of the plan and
its pre-age 65 mandator}^ retirement policy precedes or follows the
enactment of the A.D.E.A. in 1967, but rather on whether the retire-
ment plan, and particularly its benefit level, is bona fide. The Supreme
Court's denial of the petition for certiorari in Zinger, coupled with
the Court's decision in McMann, indicates that pension plans with
mandatory retirement features prior to age 65 fall within the 4(f)(2)
exception if the plan was either (1) established prior to the enactment
of the A.D.E.A. in 1967, or (2) established subsequent to 1967 but
contains a benefit schedule sufficiently large to make the plan bona
fide. Whether a post-1967 plan mandating retirement prior to age 65
but containing a very meager benefit schedule is permitted under the
4(f)(2) exception remains to be seen.
Additional issues are present when the employer involved in an
A.D.E.A. action is a state or local government acting as an employer.
This Report, supra, discusses at length the constitutional limitations
of Congressional power in the context of the federal relationship.
With regard to the applicability of the A.D.E.A. to state and local
governments in light of National League of Cities, et at., v. Usery,18: it
appears that federal law prohibiting employment discrimination by
state and local governments, and having only a slight impact on the
fiscal operations of the regulated government entity, is not prohibited
by National League of Cities. A number of courts have so held in
recent months.19 The precise significance of National League of Cities,
•5 Id. at 4046.
i« 500 F. 2d 212 (5th Cir. 1974).
v 549 F. 2d 901 (3d Cir. 1977), cert, denied. 96 U.S.L.W. 3436 (1978).
is 426 U.S. 833 (1976).
» See, e.g., Usery v. Bd. of Sduc. of Salt Lake Ciiy. 421 F. Supp. 718 (D. Utah 1976); Usery v. Bettendorf
Community School Dist., 423 F. Supp. 637 (S.D. Iowa 1967); Christei^en v. Iowa, 417 F. Supp. 423 fN.D.
Iowa 1976); Usery v. Allegheny County lust. Dist.. 544 F. 2d 148 (3d Cir. 1976), cert, denied, 45 U.S.L.W. 3651
(1977) ; Usery v. Charlestown County School Sys., No. 76-2340 (4th Cir. July 25, 1779) ; Usery v. Fort Madison
Community School Dist., No. C 75-62-1 (S.D. Iowa, motion to dismiss denied Sept. 1, 1976); Us^ry v.
Sioux City Community School Dist., No. C 76-4024 (N.D. Iowa, motion to dismiss denied Aug. 20, 1976);
Riiey v. Univ. of Lowell, Civ. No. 76-11 18-M (D. Mass., motion to dismiss denied July 22, 1976).
74-365— 7S 3
28
and alternative bases of Congressional power, are discussed above.20
A related issue involves the ability of federal courts to award money
damages to be paid by a state government, a clear possibility under
the Act.21 As is discussed at length earlier in this report,22 the 11th
Amendment issue just described is resolved in favor of federal court
jurisdiction to award money damages against a state once it is ap-
preciated that the Age Discrimination in Employment Act is enacted
pursuant not only to Congress' power under the Commerce Clause,23
but also an exercise of Congressional power under section 5 of the
Fourteenth Amendment.
Securities Acts
Existing federal law regulating the securities markets represents
an ongoing federal involvement in state and municipal pension funds.
It is well established that the antifraud provisions of the Securities
Act of 1933 1 and the Securities Exchange Act of 1934 2 apply to
issuers of state and local government securities.3 That is, state and
local government issuers must disclose to potential investors all infor-
mation that might reasonably be useful to potential investors in
reaching an investment decision. As has often been stated, the focus
is on materiality. That which is material to the investment decision
must be fully and fairly disclosed to the prospective purchaser, if
liability under the antifraud provisions of the '33 and '34 Acts is to
be avoided. "A fact is material if it concerns information about which
an average prudent investor ought reasonably to be informed before
purchasing the security." 4
The Securities Act Amendments of 1975 5 did not alter this basic
regulatory scheme. These amendments do significantly increase fed-
eral regulation of the municipal securities markets. But regulation
of the issuer directly is not changed. State and municipal issuers
remain subject to the antifraud provisions of the Acts, and remain
exempt from predisclosure registration and other Securities and
Exchange Commission pre-sale regulation.
Despite lengthy experience with antifraud actions based on the
'33 and '34 Acts, the precise role that information relating to an
issuer's pension plan plays in full and fair disclosure of all material
information is far from clear. Few actions have been brought under
the Securities Acts in which the plaintiff has claimed a governmental
issuer failed to meet the antifraud disclosure requirements, thereby
causing injury to the prospective purchaser.6 There are no significant
reported decisions in which such non-disclosure or misleading dis-
closure involved the municipal or state issuer's retirement systems.
In conclusion, it appears that federal law regulating the issuance
and sale of securities, in theory, is applicable to state and municipal
issuers of securities. The precise significance of this form of federal
regulation, specifically in terms of the kind of information relating
to a pension plan which a governmental issuer must disclose, has not
been clarified either by statutory or case law.
Supra, p. 17.
* 20 P.S.C. §(',20 (1970).
Supra, p. 16.
a U.K. CONST, art I. §8, cl.3.
« 15 U.S.C. §77(Q) (1976).
I 16 U.S.C. §78 j(b) (1076).
= SF.C v. Charles A. Morris and Assoc. Inc.. 386 F. Supp. 1327 (W.D. Tenn. 1073).
* Johns Hopkins Cuiv v. Button, 422 P. 2d 1124 (4th Cir. 1070, cert, denied., 416 U.S. 016 (1074).
* Pub. L. No. 04-20, 80 Stat. 07 (1075).
* See, e.q., Ycomans v. Kentucky, 614 F. 2d 003 (6th Cir. 1075); SEC v. Washington County Utility Dist.,
No. 2-77-15 (E.D. Tenn. 1077).
29
A second and extremely topical securities law involvement in pen-
sion and welfare benefit plans, theoretically including public employee
retirement systems, centers on the recent decision by the Seventh
Circuit Court of Appeals in Daniel v. International Brotherhood of
'Teamsters.7 In Daniel, the Court of Appeals affirmed the holding of the
District Court that mandatory participation by an employee in a non-
contributory pension plan represents the sale of a security by the plan
to the participant, thereby making applicable to the plan the antifraud
(disclosure) provisions of the Securities Acts.8 Presumably a Daniel
theory is more feasible in the context of a contributory plan, in
that it is more easity appreciated that the decision to enter into an
employment relationship represents an investment decision by the
prospective empk^-ee in terms of the pension plan.
The significance of the Seventh Circuit's decision is still far from
clear. Review has been granted by the Supreme Court,9 and a number
of amici curiae urging reversal seem likely.10 Additionally, a number of
district courts have reached decisions contrary to Daniel on similar
facts.11 Furthermore, Daniel itself is still at a preliminary, albeit
vital, stage. The present decision by the Seventh Circuit and its appeal
to the Supreme Court involve denials of defendant's motions to
dismiss the plaintiff's complaints on the ground that the trial
court lacked subject matter jurisdiction and that plaintiffs failed
to state a claim upon which relief could be granted; that isr that the
Securities Acts create no cause of action based upon the non-disclosure
which plaintiff has alleged. Thus no finding of liability has been made,
and the courts have not yet had the opportunity to consider what
represents "materiality" in the context of the purchase of a security
in the form of participation in a plan, when an}" such disclosure must
be made, what standard (e.g. scienter, negligence) will be used to de-
termine liability, and so on.
It should also be noted that the Securities and Exchange Com-
mission has recently taken an increasingly expansive view of securities
law and fraud in the context of pension and welfare benefit plans.
In S.E.C. v. Shenker, 12 the U.S. District Court for the District of
Columbia permanently enjoined defendants from continued violations
of the antifraud provisions of the Securities Acts. Two of the counts
in the S.E.C. complaint, upon which the permanent injunction and
a related consent decree were based, charge that certain trustees of
a pension fund and a welfare fund violated the antifraud provisions of
the Securities Acts by failing to disclose their participation in a course
of conduct through which assets of the employee benefit plan trust
funds Were used for the benefit of persons other than the participants
in the funds. It is apparently the view of the S.E.C. and the District
Court issuing the injunctions and approving the consent decrees in
' 561 F. 2d 1223 (7th Cir. 1977) Cert, granted, No.77-7.53, Feb. 21, 1978.
". 8 Supra, notes 1 and 2. . I . - .
c No. 77r753 Feb. 21.1978.
10 Amici curiae before the 7th Circuit included: SEC, Gray Panthers, Institute for Public Interest Rep-
resentation. Teamsters for a Democratic Union, Secretary of Labor, ERISA Industry Committee, and the
National Coordinating Committee for Multiemployer Plans.
11 Hurnv. Retirement Trust Funds, Etc., 424 F.Supp.SO(CD. Cal. 1976); Weins v. International Brother-
hood of Teamsters, CA. Number 7<j-2">17R, (CD. Cal. 1977): Robinson v. United Mine Workers of America
Health and Retirement Funds. Number 77-3398 (D.D.C 1977).
M No. 77-17S6 (D.D.C. 1977).
30
S.E.C. v. Shenker that fiduciary breaches by pension and welfare plan
officials, if not disclosed, represent violations of the Securities Acts. 13
Unresolved issues involving astronomical sums abound for govern-
mental pension and welfare plans if Daniel is upheld. The entire
concepts of (1) materiality in the context of a governmental plan
issuer and (2) a plan participant or prospective participant as a pur-
chaser of a security in the form of an interest in the pension or welfare
plan, are too novel to be considered with any confidence or certainty.
Standards which will determine retroactive liability, collective
bargaining considerations, and numerous other issues will have to be
addressed. The tremendous concern expressed by plan sponsors, and
others in the private sector, following Daniel, is equally relevant in the
context of governmental plans. If Daniel is upheld, or not firmly
reversed, and the Securities and Exchange Commission continues in
its increasingly aggresive effort to apply the antifraud provisions
of the Securities Acts to pension and welfare plans, public employee
retirement systems will be faced with a federal statutory, regulatory,
and enforcement framework of considerable significance.
Inteknal Revenue Code
The Internal Revenue Code of 1954 1 is of obvious significance to
public employee retirement systems. The degree to which public
employee retirement systems are subject to various Code provisions
has a direct impact on virtually every aspect of a state or local govern-
ment employee benefit plan.
Before considering to what extent public employee plans are sub-
ject to the qualification requirements of the Internal Revenue Code,2
the result of receiving "qualified" status, and the relevancy to state
and local government plans, should be noted.
Briefly stated, qualification of a pension plan under section 401(a)
of the Internal Revenue Code results in three major tax benefits for
employees, employers, and their pension plans:
(1) The employer's contributions to the plan are deductible
when made, even if the employee is not vested in them at that
time; 3
(2) the earnings of the pension trust funds are not taxed
currently; 4
(3) the contributions made by an employer to a plan on behalf
of an employee are not currently imputed to the employee for
income tax purposes, even if vested.5 Also, advantageous tax
treatment is afforded to a participant who receives a lump-sum
distribution from a qualified plan,6 and favorable income tax
treatment 7 and estate tax treatment 8 are available with regard
to death benefits paid from a qualified plan.
«* Compare Santa Fe Industries, Inc. v. Green, 430 U.S. 462, (1977), in which the Supreme Court holds
that fiduciary breaches in the absence of nondisclosure are not actionable under the antifraud provisions
of the securities acts.
i I.R.C. § 1 etsoq.
U.R.C. §401 et seq.
» Id. § 404.
« Id. §501(a).
*Id. § 402(a).
• Id. § 402(e).
T Id. 5 101(b).
• Id. § 2039(c).
31
A number of observations are in order with regard to state and
local government plans and the tax implications of characterizing a
retirement plan as qualified. Because gross income does not include
income accruing to a state or local government,9 the advantage to
the employer in having a qualified plan — immediate deductibility of
employer contributions, even if not vested in the employees — is not
relevant. Whether the second tax advantage to qualified status —
deferral of taxation of the income of the pension trust — is of relevance
to governmental plans is unclear. Where the trust is part of the
governmental entity,10 trust income presumably would be imputed
to the government and tax exempt on that basis. With minor excep-
tion, the issue has not been litigated or addressed administratively
by the Internal Revenue Service.
It is clear that the third advantage of qualified status-deferral of
recognition as current income by the employee of employer con-
tributions in which the employee is vested — is relevant for govern-
mental plans. Deferral of recognition of income is a matter of grace
on the part of the federal government,11 and the fact that the income
in this instance is derived from a governmental employer is of no
consequence. If the governmental plan is not treated as qualified,
the plan participant must currently recognize as income the con-
tributions made b}^ the employer, to the extent the participant
is vested in the contributions.12 If the governmental plan is treated
as qualified, then the participant may defer recognition of the value
of his vested, funded interest in the plan until it is actually distributed
to him.13 Such actual distribution of the participant's plan interest
and recognition of income will probably occur after the participant
is no longer an active employee. A considerable tax savings may
result in that the participant may recognize the income in a year in
which taxable income is considerably less than the year(s) in which
the participant became vested in the employer's contribution. Also,
as in the private sector, the plan participant of a qualified govern-
mental plan is eligible to receive favorable tax treatment if his in-
terest is distributed in the form of a lump sum distribution.14
It is clear that almost all of the substantive qualification require-
ments added to the Internal Revenue Code by ERISA specifically
exempt governmental plans from coverage. A governmental plan
is denned as "a plan established or maintained for its employees by
the . . . government of any State or political subdivision thereof,
or by any agency or instrumentality of any of the foregoing . . . . m5
Such governmental plans are specifically exempted from the Code
provisions added by ERISA which relate directly to participation,16
vesting,17 funding,18 prohibited transactions,19 joint and survivor
annuities,20 plan merger and consolidation,21 alienation and assign-
9 Id. § 115.
10 See, e.g., Fitzpatrick v. Bitzer, 427 U.S. 445 (1976).
" New Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934).
121.R.C. § 402(b).
is Id. § 402(a).
J* Ii. § 402(e).
is Id. § 414(d).
is Id. §410(c)(l)(A).
17 Id. § 411(e)(1)(A).
i» Id. § 412(h)(3).
19 Id. § 4975(g)(2).
»E §401 (a) (11).
2i Id. § 401 (a) (12).
32
ment of plan benefits, 22 parent of benefits,23 certain Social Security
benefit increases,24 and withdrawal of employee contributions.25
However, governmental plans were not exempted from the ERISA
Internal Revenue Code provisions placing specific limitations on
benefits and contributions under qualified plans.26
Importantly, qualified governmental plans appear to remain sub-
ject to the Internal Revenue Code participation, vesting, funding, and
fiduciary standards applicable to all qualified plans before the enact-
ment of ERISA. Code section 410, while exempting governmental
plans from the new participation standards,27 states that such plans do
remain subject to the pre-ERISA participation standards.28 Thus to
be qualified, governmental plans must in theory cover 70 percent of all
the employer's emplo3^ees, or 80 percent of all employees who are
eligible to benefit in the plan if 70 percent or more of all the employees
are eligible to benefit, and employees who are employed more than 20
hours per week for at least five months per year. In addition, such
plans apparently must not have service requirements in excess of
five years, or otherwise discriminate in favor of highly compensated
employees.29 Similarly, in the vesting area, ERISA adds Code section
411, which exempts governmental plans,30 but preserves the pre-
ERISA Code vesting requirements for governmental plans.31 Thus
governmental plans to be qualified must provide for vesting (1) upon
a participant's attaining normal retirement age or the age and service
requirements contained in the plan, (2) upon plan termination, and
<3) to generally prevent discrimination in favor of highly compensated
employees.32
With regard to funding, Code section 412, added by ERISA,
exempts governmental plans from its scope,33 and preserves the pre-
ERISA safe-haven rule relating to whether a plan termination has
occurred upon suspension of contributions by the plan sponsor.34
Generally, ERISA did not change the pre-ERISA "funding" require-
ments applicable to governmental plans. Prior to the enactment of
ERISA, however, in the event of the complete suspension of contribu-
tions under a governmental plan, an IRS "safe-haven" rule applied
wherein the plan would not be considered "terminated" if contribu-
tions equal to at least normal cost plus interest on the unfunded lia-
bility had been made (thus preventing the initial unfunded liability
from increasing).35 This safe-haven rule continues to apply to govern-
mental plans in the post-ERISA period. In the event a governmental
plan, subject to the Internal Revenue Code, terminates or is deemed to
be terminated by the Internal Revenue Service, plan assets must be
allocated to those benefits in which plan participants are vested (a
provision primarily intended to prevent a reversion of plan assets to
the plan sponsor).36
» Id. §401 (a) (13).
«3 Id. § 401(a) (14).
*< Id. § 401 (a) (15).
" Id. & 401 (a) (19).
2» Id. § 415.
2? Supra, note 16.
« I.R.C. § 410(c)(2).
» Id. § 401(a)(3) and (4) (Sept. 1, 1974).
ao Id. § 411(e)(1)(A).
3i Id. § 411(e)(2).
« Id. § 401(a)(4) and 401(a)(7) (Sept. 1, 1974).
33 Supra, note 18.
s« U.K. Rep. No. 93-1280, 93d Cong., 2d Soss. 291 (1974).
3« Treas. Rep. § 1.401 -6(c)(2) (Sept. 1, 1974).
a* I.R.C. § 401(a)(7) (Sept. 1, 1974); I.R.C. § 412(h).
33
With regard to fiduciary standards, ERISA adds Code section
4975, but exempts governmental plans from its scope.37 Pre-ERISA
standards are maintained for governmental plans, however.38 Thus,
in theory, a qualified governmental plan may not lend any part of
its income or corpus to a creator of the trust, substantial contributor
to the trust, or similar entity, without adequate security. The plan
also may not pay excessive compensation to such a person, purchase
securities at excessive prices from such an entity, sell securities at
an undervalued price to such an entity, etc.39
Until recently (see next paragraph), Internal Revenue Service
Rulings suggested that governmental plans are subject to these
various qualification requirements of the Internal Revenue Code.40
This interpretation by the Service, it should be carefully noted,
has had virtually no practical significance to state and local plans.
Enforcement of the qualification standards against public plans
has been for the most part non-existent. No plans have been dis-
qualified, and it does not appear that the Service has ever success-
fully imputed to a public plan participant the value of his vested,
funded, pension plan interest in a situation in which the participant
sought to defer recognition of that income; i.e. receive the benefit
of having the plan viewed as qualified.
Furthermore, following a recent flurry of protest when the Service
did begin to apply the qualification requirements to state and local
governmental plans, the Service announced 41 that it will reconsider
whether (1) the qualification requirements apply to public plans, and
(2) the trusts of such plans are subject to tax on their income. Until
such a review is completed, the Internal Revenue Service has indicated
it will resolve these issues in favor of the taxpayer or governmental
unit; that is, continue to treat the plan as if it were qualified.42 Any
attempt to explain this attitude on the part of the Internal Revenue
Service is, of course, highly speculative. It does appear, however,
that the existence of a qualification letter for the retirement plan
for federal judges 43 — a plan thought to be highly discriminatory in
favor of highly compensated employees — has played some role in
the decision not to challenge the status of governmental plans.
Of interest and importance in the context of governmental plans
and the Internal Revenue Code is P.L. 94-236, 44 enacted by Congress
in 1976 in response to the New York City fiscal crisis. A key element
of the refinancing program for New York City in 1976 involved the
purchase by five New York City pension funds of New York City
bonds. Great concern was expressed by the trustees of the pension
plans, the Internal Revenue Service, and the Congress that the pro-
posed investments violated the exclusive benefit rule of Code section
401(a) and certain fiduciary provisions of Code section 503(b), as
those provisions applied to governmental plans (see above). P.L.
37 Supra, note 19.
3SI.R.C. § 503(a)(1)(B).
w/d. § 503(b).
*9 Rev. Rul. 72-14. 1972-1 C.B. 106.
« T.R. 1869, Aug. 10, 1977.
« Id.
« Rev. Rul. 61-218, 1961-2 C.B. 102.
« 90 Stat. 238 (94th Cong. 2d Sess., 1976).
34
94-236 waived the prohibited transactions and exclusive benefit rules
of the Internal Revenue Code with regard to the purchase of New
York City securities by the five city pension funds, a step necessitated
by the general unmarketability and high risk nature of such bonds at
that time. The Ways and Means Committee, in approving the bill,
stressed that it should not be interpreted as a precedent under which
governments can use plan assets to assist cities in raising revenues
during periods of financial crisis, even though such use of plan assets
might violate the exclusive benefit or prohibited transaction rules of
the Internal Revenue Code.45 Despite the fact that those Code pro-
visions which are applicable to governmental plans are generally not
enforced by the Internal Revenue Service, the presence of such
provisions of law serves as a significant form of federal regulation of
governmental pension plans, as the history of P.L. 94-236 demon-
strates.
Much recent activity has focused on the issue of whether state
and local government plans are subject to various reporting require-
ments contained in the Internal Revenue Code. The annual registra-
tration statement is limited to plans subject to the vesting require-
ments of ERISA.46 Inasmuch as governmental plans are exempted from
those requirements,47 they are similarly exempted from the annual reg-
istration statement. The annual return requirement contained in the
Code,48 however, does not include an exemption for governmental
plans, and the Internal Revenue Service has taken the view that
governmental plans are subject to the annual report requirement.49
Penalties for failure to file the annual report are $10 per day for the
period in which the report has not been filed, and the total penalty
may not exceed $5,000.50
In summary, pre-ERISA Internal Revenue Code provisions relating
to retirement systems generally apply to state and local government
plans. Certain Code provisions added by ERISA, such as those relating
to limitations on benefits and contributions, and annual returns, also
apply to governmental plans, although it is clear that the Internal
Revenue Code provisions added by ERISA relating to participation,
vesting, funding, prohibited transactions, and so on, are not appli-
cable. The significance of Internal Revenue Code regulation of elate
and local governmental plans has not been appreciated largely because
the Internal Revenue Service has been lax to enforce the Code in the
context of state and local government retirement systems. The recent
formalization of this non-enforcement policy [in I.R. 1869 51 indicates
that it will continue for at least the immediate future.
In those few instances in which the Service has enforced or
threatened to enforce qualification requirements against public plans,
the impact on the plans involved has been quite significant. A pension
plan for the police and firemen in St. Joseph, Missouri, for instance,
paid several thousand dollars in "income taxes" on earnings of the
pension trust to the Internal Revenue Service in the early 1970's. It
is clear that a vigorous effort by the Internal Revenue Service to
enforce the penalties upon failure to file the section 6058 annual
« II.R. Ron. No. 94-851, 94th Cong., 2d Sess. (1976).
• I.R.O. § 6057(a)(1).
47 Supra, note 17.
« [.E.G. ?> 6058.
«* LB. 1798, Apr. 21, 1977.
» I.R.C. § 6058(d) and 6652(f).
* Supra, note 41.
35
report form would have a major impact on public employee retire-
ment systems. As with so many other federal laws already enacted,
the Internal Revenue Code represents an extensive and significant
form of federal regulation of public employee retirement systems, the
significance of which has not been realized largely because the govern-
ment has chosen not to enforce the relevant statutory provisions.
Social Security
The federal Social Security Program 1 is of obvious significance to
state and local government retirement systems. Generally, under
existing law, employees of state and local governments are covered by
Social Security only if the government unit and the Secretary of
Health, Education, and Welfare have entered into voluntary agree-
ments to provide such coverage.2 There are a number of important
variations on this voluntary theme.3 For instance, a voluntary cover-
age agreement may not be placed in effect for employees presently
included in a state or local retirement plan unless a majority of eligible
employees, in a secret, written, ballot referendum, approve Social
Security coverage.4
A state or local government may terminate coverage for a group of
employees by giving notice two years in advance, after the coverage
has been in effect for five years. The notice of desire to terminate may
be withdrawn before the expiration of the two year notice period.
Once coverage has been terminated for a group of employees, it can
never be reinstated for that group.5
At present, approximately 70 percent of all state and local govern-
ment employees are subject to Social Security coverage.0 Recalling
that the governmental employer and the covered employee each con-
tributes 6.05 percent of the employee's gross earnings to Social Secu-
rity, it is clear that whether a group of public employees is subject to
Social Security coverage will dramatically affect the availability of
funds to be contributed to the state or local government retirement
system. Benefit levels, integration formulae, variety of benefits, and so
on of the state or local government pension plan will obviously be
vitally affected by whether the employees covered by the plan are also
covered by Social Security.
The termination of coverage provisions of Social Security is of
increasing significance to public employee retirement systems. A
large number of public employee groups, representing over 350,000
workers, submitted notices of intent to terminate Social Security
coverage in the period from 1973 to 1975.7 A number of these plans
withdrew their notices of intent to terminate coverage prior to the
expiration of the two year notice period, presumably concluding that
comparable benefits could not be obtained elsewhere at a comparable
cost.8
i 42 T.S.C. § 301 et seq. (1970).
3 42 U.S.C. § 418 (1970).
» J<i.
*Id.
s id.
« See Part IV, Chapter B.
" Su-tement of James B. Cardwell, Commissioner of Social Security, reported in 151 BNA Pension
Reporter A-l.
8 id.
36
The enactment of the Social Security Financing Amendments of
1977 9 changes the Social Security system in a number of extremely
significant ways. Contributions to the Social Security system by both
employers and employees will rise dramatically, in terms of both the
rate itself and the maximum earnings subject to the tax. As the cost-
benefit formula changes, it can be expected that a number of govern-
mental plans will re-assess their benefit structures and participation
or non-participation in Social Security.
Extremely significant changes in the Social Security system with
direct implications for federal, state and local retirement systems are
present^ under consideration by the federal government. In accord-
ance with Public Law Number 95-216, the Secretary of Health,
Education and Welfare is required to undertake a study and report on
mandatory coverage under Social Security of employees of federal,
state and local governments in consultation with the Office of Manage-
ment and Budget, the Civil Service Commission, and the Department
of the Treasur}^ The study is to examine the feasibility and desirability
of coverage of these employees and is to include alternative methods of
coverage, alternatives to coverage, and an analysis under each alterna-
tive of the structural changes which would be required in retirement
systems and the impact on retirement systems benefits and contri-
butions for affected individuals. The report to be made to the Presi-
dent and the Congress is due two years after enactment.
Revenue Sharing
It is clear that a great many state and local governments use por-
tions of monies received under the State and Local Fiscal Assistance
Act 1 to fund governmental pension plans.2
As passed in 1972, the Federal Revenue Sharing Act contained few
limitations on the ways in which states in receipt of revenue sharing
funds could use such funds. The 1972 Act, however, did require that
units of local government receiving such funds use them only for
"priority expenditures", defined to mean "only —
(1) ordinary and necessary maintenance and operating expenses
for—
(A) public safety (including law enforcement, fire protec-
tion, and building code enforcement),
(B) environmental protection (including sewage disposal,
sanitation, and pollution abatement),
(C) public transportation (including transit systems and
streets and roads),
(D) health,
(E) recreation,
(F) libraries,
(G) social services for the poor and aged, and
(H) financial administration, and
(2) ordinary and necessary capital expenditures authorized by
law."3
» Pub. L. No. 05-216, 91 Stat. 1509 (1977).
» 31 U.8.C. § 1221-1264 (Pupp. V 1975).
2 The Public Strricr Employe Rttirement Income Security Act of 1976: Hearings on II. R. 9165 and T1.R. 808
before the Subcomm. on Labor Standards of the House Comm. on Education and Labor, 94th Cong., 1st Sess.
(1975) (Statement of John M. Milliron).
» U.S.C. § 1222 fSupp. V 1975), (repealed by State and Local Fiscal Assistance Amendments of 1976,.
Pub. L. No. 94-488 § 3(a), 90 Stat. 2341).
37
The absence of any further refinement of what constitute "priority
expenditures" led some observers to conclude that funds could be used
by local governments for virtually any purpose by reallocating locally-
raised revenues from "priority categories" to "non-priority categories",
and using the federal revenues for "priority categories".4
The few cases in which proposed local government use of federal
revenue sharing funds was challenged appear to support this view.5
Given that states under the 1972 Act had unrestricted use of revenue
sharing funds, and local governments were limited in permitted uses
only to broadly denned "priority categories", use of revenue sharing
funds by state and local governments to fund governmental pension
plans appears completely appropriate. It should also be noted that the
states and localities are required to report on the use of revenue shar-
ing funds,6 and hence presumably the Congress was fully aware that
funds were being used by governments to fund retirement systems.
Finally, whatever doubt might have remained regarding the propri-
ety of local governments' use of federal revenue sharing funds to fund
or pay pension benefits was removed by the 1976 amendments to the
Federal Revenue Sharing Act.7 The limitation to "priority categories"
for local government use of revenue sharing funds was repealed,8 thus
leaving local governments, like state governments, completely free to
use federal revenue sharing funds to fund or pay governmental retire-
ment benefits.
Fair Labor Standards Act
The Fair Labor Standards Act 1 affects public employee retirement
systems in two ways.
The Act establishes minimum wage and overtime provisions for
employees. The Act as originally passed in 1938 2 excluded states and
political subdivisions thereof from the definition of "employer".
In amendments to the Act in 1966,3 the exemption for states and poli-
tical subdivisions was narrowed, and most employees of state and
municipal schools, hospitals, and institutions were brought within
the coverage of the Act. The Supreme Court sustained the constitu-
tionality of this extension in Maryland v. Wirtz? holding that "If a
State is engaging in economic activities that are validly regulated by
the Federal Government when engaged in by private persons, the
State too may be forced to conform its activities to federal regulation".5
The Act was again amended in 19746 to bring within its coverage
all state and local government entities. The Supreme Court, in National
League of Cities v. Usery7 (discussed at length, supra), declared
this extension of coverage to be violative of the Tenth Amendment's
reservation of power to the states and hence unconstitutional. The
Court also reversed its decision in Maryland v. Wirtz. Thus subsequent
to the June, 1976, decision in National League of Cities, employees
* See, e.g.. The Revenue Sharing Act of 1972: Untied and Untraceable Dollars from Washington, 10 Harv. J.
Lesis. 276 (1973).
s Yovetich v. McClintock, 165 Mont. 80, 526 P. 2d 999 (1974); Mathews v. Massell, 356 F. Supp. 291 (ND.
Ga. 1973).
6 31 U.S.C. § 1241 (Supp. V 1975).
7 State and Local Fiscal Assistance Amendments of 1976, Pub. L. No. 94-488, 90 Stat. 2341.
« Id. §3(a).
1 29 U.S.C. § 201 et seq. (1970).
2 52 Stat. 1060, Chanter 676 (1938\
3 Pub. L. No. 89-601, 80 Stat. 830 (1966).
< 302 U.S. 183 (1968).
« Id. at 197.
• Pub. L. No. 93-259, 88 Stat. 55 (1974).
7 426 U.S. 833 (1976).
38
of states and political subdivisions generally are not beneficiaries of
the protections of the minimum wage and overtime provisions of the
Fair Labor Standards Act. The F.L.S.A. remains applicable, however,
to those public employees engaged in enterprises not integral to the
general functions of the state or local government employer.
To the extent that benefits or funding requirements are based on
employees' compensation, state and local governmental plans have
been, and to some degree, continue to be, affected by the minimum
wage and overtime provisions of the F.L.S.A.
The equal pay provisions of the Fair Labor Standards Act 8 also
affect public employee retirement systems. These provisions generally
prohibit employers covered by the Act from discriminating on the
basis of sex with respect to the payment of wages to employees. As
discussed above, certain state and local governmental employers were
made subject to the Act, including its equal pa}^ provisions, in 1966,
and all such employers were brought under its coverage in 1374. A
large majority of the courts that have addressed the issue9 have held
that this aspect of the F.L.S.A. is distinguishable from the Act's
minimum wage and overtime provisions in both its impact on basic
state and local government functions as well as the jurisdictional
basis of its enactment, and is not unconstitutional under the Supreme
Court's decision in National League of Cities v. Usery.10 Thus state and
local governments continue to be subject to the equal pay provisions
of the F.L.S.A., and state and local governmental retirement systems
continue to be affected by the Act to the extent the systems are affected
by sex-based variations in the employees' compensation.
Labor Management Relations Act
Public employee retirement systems are not affected by the National
Labor Relations Act and the Labor Management Relations Act of
1947. 1 These Acts establish the right of employees to bargain collec-
tively through representatives of their own choosing, and otherwise
engage in other concerted activities for the purpose of collective
bargaining or other mutual aid or protection. It also establishes a
series of prohibitions limiting employer actions which interfere with
basic rights guaranteed to employees under the Act. If the L.M.R.A.
applies to an employer-employee relationship, the terms of pension
and welfare plans, at least for active employees,2 are clearly among the
topics which are to be negotiated by the employee's collective bargain-
ing agent and the employer. This feature of the L.M.R.A. has obviously
been of extraordinary significance in the private sector.
The L.M.R.A., however, clearly excludes from its definition of
employer "any state or political subdivision thereof",3 thereby remov-
ing from its coverage the vast majority of what are commonly thought
of as public employers. Hence the development of benefit plans by
such public employers for public employees is not affected by the
Labor Management Relations Act.
•29 U.S.C. } 206(d) H 970).
0 See, e.a., Usery v. Allegheny County Inst. Dist., 541 F. 2d 148 (3d Cir. 1070), cert, denied, 4n U.S.L.W.
3fi;,i (1077); Userv v. Dallas Independent School Dist., 421 F. Supp. Ill (N.D. Tex. 1976); Christenson v.
Iowa. 417 F. Supp. 423 (X.D. Iowa 1976); Us,>ry v. Meyer Memorial Hosp., 428 F. Supp. 1368, 1372 (note
8) (W.D. X.Y. l',77).
' 29 U.S.C. § 141 et srq. (1970).
1 Allied Chemical Workers v. Pittsburgh Plate Glass Co., m U.S. 157 (!971).
> 29 U.S.C. § 152(2) (1970).
39
It should be noted that the interpretation of ''state or political
subdivision thereof" for purposes of the definition of "employer"
under the L.M.R.A. is an ongoing process. There exist a number of
retirement systems which are commonly thought to be maintained
by states or~ political subdivisions thereof, but which might; if ever
challenged, be found to be maintained by an "employer" for L.M.R.A.
purposes. Certain kinds of state universities and quasi-public utility
and transit authorities, for instance, might be found to be maintained
by "employers" for purposes of the L.M.R.A., were the status of
certain employers ever questioned.
Comprehensive Employment and Training Act
Public employee retirement systems are affected by the Compre-
hensive Employment and Training Act of 1973. 1 Under the Act,
federal grants are made to state and local governments which in
turn may employ persons in public service jobs. Such employees
must be compensated for wage and fringe benefit purposes at the
same levels and to the same extent as other employees of the employer.2
Additionally, the Emergency Jobs and Unemployment Assistance
Act of 1974, 3 which amends C.E.T.A., requires that public service
woikers under the Act engaged in construction-type jobs must be
paid the prevailing wages and fringe benefits, including interests in
employee benefit plans, for similar construction in the locality.4 The
requirements in these Acts that employees receive fringe benefits
comparable to non-Act employees result in the acquisition by public
service workers of interests in state and local public emploA'ee retire-
ment systems.
Bankruptcy Act
The 1976 revisions to the Bankruptcy Act 1 are of extreme im-
portance to public employee retirement systems in the conceiv-
able event that a local government entity becomes bankrupt. The
1976 revision recognizes that "A municipal unit cannot liquidate
its assets to satisfy its creditors totally and finally. Therefore the
primary purpose of Chapter IX is to allow the municipal unit to
continue operating while it adjusts or refmancies [sic] creditor claims
with minimum (and in many cases, no) loss to its creditors." 2 Com-
plex procedural requirements are set out in an attempt to achieve a
fair balance between creditors of the bankrupt municipality and the
municipality itself, with special consideration given to the special
nature of a municipality in terms of its assets and its obligations to its
citizens.
When a municipality enters into the procedures contained in the
Bankruptcy Act, the retirement systems of that municipality enter a
stage even more novel and unsettled than municipal bankruptcy
itself. Depending upon the relationship between the pension plan and
the bankrupt plan sponsor, the pension plan may be in the position of
a creditor to the bankrupt municipality, seeking to force the munici-
pality to honor its unpaid funding obligation to the plan, or it may be
in the position of an asset of the bankrupt municipality, eagerly
viewed by creditors as a liquid asset capable of satisfying the claims of
i 29 T.3.C. § 801 et seq. (Supp. V 1975) ;
-' 2*-) U.S.C. § 843(a) (2) and (4) (Supp. V 1975).
3 Pub. L. No. 93-567, 88 Stat. 1845 (1974).
i . U.S.C. § !,64 (Supp. V 1975).
1 Pub. L. No. 94-260, 90 Stat. 315 (1976).
2 H.R. Rep. No. 94-686, 94th Cong., 1st Sess. 6, reprinted [1976] U.S.C. C.A.N. 539, 543.
40
deserving creditors. Conceivably, the retirement system could be both
a creditor and an asset of the debtor municipality. Obviously, the
provisions of Chapter IX of the Bankruptcy Act are of extreme
significance to a public employee retirement system upon the bank-
ruptcy of the sponsoring municipality.
Military Selective Service Act
The Military Selective Service Act 1 affects the operation and pro-
visions of state and local government retirement systems. The Act
is intended to insure that veterans will have available to them the
jobs they left in order to enter military service. The Act generally
requires that a veteran who timely re-applies for his pre-military job
must be restored to a position of like seniority, status, and pay. The
law provides that for purposes of insurance or other benefits offered
by the employer, the returning veteran must be considered as having
been on furlough or leave of absence during his period of training and
service in the armed forces. Certain limitations relating to the quali-
fications of the veteran, availability of the position, and so on, are
found in the statute.
Prior to 1974, it was clear that the law applied on a mandatory
basis to all private employers 2 and to the federal and District of
Columbia governments as employers.3 It was also clear that the Act
did not apply on a mandatory basis for state and local governments.4
Congress simply suggested that state and local governments as
employers afford these re-employment benefits to returning veterans.5
In 1974, Congress amended the Act 6 to subject state and local
government employers to the same requirements which had been
imposed on the federal government and District of Columbia govern-
ments in their employer capacity, and on private employers, since
the enactment of the predecessor Act in 1940.
Whether an employer must credit a returning veteran with service
for vesting purposes, benefit accrual purposes, and other pension and
welfare plan purposes, has frequently been litigated with regard to
emplo3'ers other than state and local governments. There is no reason
to believe, however, that the same interpretations of the Act will not
be applied to those situations involving state and local government
employers made subject to the Act by the 1974 amendments.
Alabama Power Company v. Davis 7 is a very recent Supreme Court
case directly on point. Alabama Power Co. maintained a fairly typical
defined benefit pension plan in which the accrued benefits were deter-
mined by the number of years of credited service the plan participant
had attained. Davis had left the employ of Alabama Power Co. to
enter the military, and he returned to the Company following his
discharge. The Company refused to credit Davis for purposes of
benefit accrual for those years in which he was in the Service.
i 38 TJ.S.C. § 2021 ct scq. (Supp. V 1975).
* 50 App. U.S.C. § 459(b) (1970).
« Id.
* McLaughlin v. Retherford , 207 Ark. 1094, 184 S.W. 2d 461 (1945).
* 50 App. U.S.C. 459(b)(2)(C) (1970).
* 38 U.S.C. 5 2021 (Supp. V 1975).
7 431 U.S. 581 (1977).
41
The Supreme Court first takes note of the conflict among the
circuits with regard to the issue raised by appellee Davis.8
The High Court then reviews the cases it had already decided
under the Military Selective Service Act. It concludes that if the
benefit at issue
would have accrued, with reasonable certainty, had the veteran been contin-
uously employed by the private employer, and if it is in the nature of a reward
for length of service, it is a "perquisite of seniority" [and must be credited to the
employee]. If, on the other hand, the veteran's right to the benefit at the time he
entered the military was subject to a significant contingency, or if the benefit
is in the nature of short term compensation for services rendered, it is not an
aspect of seniority under section 9 [and hence need not be credited].9
The Court proceeds to consider the Alabama Power Company
pension plan under this framework and concludes that the accrual of
benefits in the instant plan is a perquisite of seniority and accordingly
must be granted to Davis.
It is interesting to note those factors which persuade the Court
that benefit accruals in the Alabama Power Company plan are more a
reward for length of service than in the nature of short term compensa-
tion for services rendered. The automatic earning of accruals upon the
attainment of a certain amount of service is cited. The Court notes the
lengthy (20 years, or 15 years and age 50) vesting schedule of the pre-
EBJSA plan, and strongly infers from this fact that credit for all
purposes under the plan is in the nature of a reward for services. The
"function of pension plans in the employment system" — to reward
lengthy service with the same emplover — also contributes to the
Court's finding.10
Alabama Power Co. resolves many of the questions raised by the
Military Selective Service Act as it applies to pension and welfare
plans, including plans of state and loca) governments. Service for all
purposes in a defined benefit pension plan apparently must be credited
to a returning . veteran. Presumably vesting schedules somewhat
shorter than the one at issue before the Court will not alter the Court's
analysis. One wonders, however, if a greater recognition by the Court
that pension benefits are more in the nature of deferred compensation
than a reward for lengthy service would alter the outcome. By favor-
ably citing its earlier decisions in Foster v. Dravo Corp.11 (involving
vacation pay) and Accardi v. Pennsylvania Railroad Co.12 (involving
severance pay), and indicating that these holdings are consistent with
the rationale expressed in Alabama Power Comipany, the Court indi-
cates that employers generally must credit military service for sever-
ance pay purposes but need not do so for vacation pay purposes.
Some clear analogies can be drawn from these examples. Health
benefits and prepaid legal plan benefits in most instances seem very
much like vacation pay benefits, in that they are intended as a benefit
in the nature of short term compensation.
8 Compare Jackson v. Beech Aircraft Corp. 517 F. 2d 1322 (C.A. 10th, 1975) in which it was held no credit
need be given for time in military for purposes of pension benefit accruals, longevity pay, vacation benefits,
or sick leave, with Litwicki v. Pittsburgh Plate Glass Indus., Inc., 505 F. 2d 189 (C.A. 3d 1974), in which
it was held that no credit need be given under the Act for purposes of vesting or benefit accrual, and Smith
v. Industrial Employers and Distributors Ass'n., 546 F. 2d 314 (C.A. 9th, 1976), in which it was held that
credit must be given for purposes of accrual of pension benefits.
s Supra, ncte 7 at 589.
i° Supra, note 7 at 594.
" 420 U.S. 92 (1975).
i' 383 U.S. 225 (1966).
42
But much is left unclear. Whether credit for purposes of longevity-
pay must be credited is unresolved. Similarly, the meaning of the Act
in the context of sick pay and disability plans is left unclear. In some
ways these benefits are more like perquisites of seniority than short
term compensation. In other ways, the contrary is true. No doubt the-
wording of the plan at issue in every instance will determine to a great
extent the nature of the benefit. Whether the Supreme Court's analysis
will change if the plan is a contributory one is obviously of importance
to governmental plans.
Also of importance is the Supreme Court's express reservation re-
garding whether defined contribution plans are to be treated differently
from defined benefit plans for purposes of the Act.13 A defined contribu-
tion plan was not at issue in Alabama Power Company, and thus no
direct inferences can be drawn from the Court's reservation on this
issue. Given the large number of defined contribution plans in the pub-
lic sector, particularly among the retirement systems of colleges and
universities owned by state and local governments, the resolution of
this issue is of some significance.
In summary, the Military Selective Service Act, made mandatory in
terms of state and local government employers in 1974, represents
another federal statute presently affecting public employee retirement
systems. As greater numbers of returning veterans in future years
resume employment with state and local government employers, the
Act and its interpretations will increasingly need to be considered by
public employee retirement systems.
Cost Accounting Standards Board
Legislation establishing the Cost Accounting Standards Board,1
and regulations issued by the Board,2 affect those few public employee
retirement systems which cover employees of defense contractors
and subcontractors. State universities periodically enter into defense-
contracts to conduct technical research and development, and the
pension component of such contractor's cost must be computed and
measured under the regulations issued by the Cost Accounting
Standards Board. To the extent a public plan covers employees of
contractors subject to the C.A.S.B. regulations and accounts for the
cost of that coverage in a manner inconsistent with the C.A.S.B..
requirements, this aspect of existing federal regulation of public
employee retirement systems is meaningful.
13 Supra, note. 7 at ">93 (footnote 18).
1 50 App. U.S.C. § 2K',8 (11(70).
2 4 C.F.R. § 331.30; 4 CF.R. § 412.1C-412.80 (1077);
PART III— STATE LAWS APPLICABLE TO PUBLIC
EMPLOYEE RETIREMENT SYSTEMS
Of obvious significance to public employee retirement systems are
the constitutional, statutory, and common law provisions of the state
in which the governmental plan is located. A listing of many of these
laws is contained in Appendix V of this Report.
The variety, in both scope and nature, of state law provisions
relating to public employee retirement systems, is extensive. Many
states have constitutional provisions which prohibit the impairment
of contracts and require the state to afford due process before depriv-
ing persons of life, liberty or property. Numerous states, by constitu-
tional or statutory provision, characterize plan interests as contractual
in nature. Plan provisions relating to benefit levels, contribution
formulae, eligibility, and funding requirements are frequently ad-
dressed at length by statute. Some states spell out the nature of
investments that must be made with retirement fund assets. Fre-
quently, common law is used to address an issue that has not been
directly addressed by the legislature.
In many states, no constitutional or statutory provisions are found
in vital areas such as reporting and disclosure to participants, review
of claims procedures, auditing and accounting standards, and fiduciary
responsibility. No state appears to have provisions relating to the
insuring of unfunded plan liabilities upon the termination of the plan.
The sheer complexity of the state regulatory framework is in itself
significant. Every state except Hawaii has more than one pension
system. Forty states have ten or more plans. The number and variety
of state laws affecting each plan has unquestionably produced con-
fusion among plan participants. The problem is compounded by the
frequent absence of uniform or enforceable reporting and disclosure
requirements. Some public employee retirement systems have, how-
ever, adopted beneficial plan practices in the absence of a legal
requirement to do so. In the reporting area, for instance, many plans
prepare and distribute summaries of major plan provisions, and
periodically report publicly on the financial condition and related
matters of the plan. Some states and localities have established a
claims review procedure to enable a participant whose claim for
benefits has been denied an opportunity to obtain a more independent
review of his application. The absence of any legal mandate for these
beneficial practices substantially lessens their value to plan partici-
pants. Public plan practices that are not required by any statutory or
constitutional provision can be eliminated as easily as they are estab-
lished. Frequently, a participant may not have standing to enforce
plan practices that have been established only informally. As a general
matter, plan participants receive greater protection from beneficial
plan practices that are mandated by law rather than voluntarily
introduced.
(43)
74-365—78 4
44
A closely related matter involves the interpretations which state
courts have given to state statutory and constitutional provisions
relating to governmental benefit plans.
In some instances, state law has been interpreted in a manner which
has served to strengthen the protection afforded plan participants.
The Washington Supreme Court, for instance, in Bakenhus v. City
of Seattle,1 finds under state law that a pension is deferred compensa-
tion for services rendered, and hence contractual in nature.2 The
Court goes on to state that a plan participant, upon satisfaction of
the prescribed conditions, is entitled to receive the plan benefit for
which he contracted, and that pension rights "may be modified prior
to retirement, but only for the purpose of keeping the pension system
flexible and maintaining its integrity." 3 When confronted with legis-
lation which purported to retroactively reduce the plan participants'
accrued benefit, the Court acts upon its contract-like analysis and
strikes down the legislation.
A similar example of a state law interpretation which serves to
benefit plan participants is found in Opinion of the Justices} At issue
was a proposed statutory enactment which would raise the mandatory
employee contribution rate from 5 percent to 7 percent of salary, with
no increase in benefit levels. The Massachusetts Supreme Court first
analyzes relevant state law5 and concludes that participation in the
pension plan establishes a contractual relationship which protects the
plan participant "in the core of his reasonable expectations, but not
against subtractions which, although possibly exceeding the trivial,
can claim certain practical justifications. . . ."6 In considering the
proposed increase in the contribution rate from 5 percent to 7 percent,
the Court enhances the protection participants in theory enjoy from
the contractual nature of the pension interest, and strikes down the
proposed contribution rate increase as presumptively violative of both
state statutory and constitutional as well as federal constitutional
provisions.
In Sgaglione v. Levitt,7 the New York Court of Appeals is faced with
a New York statute which purported to compel the trustee of certain
state pension funds to make specified investments with pension fund
assets, thereby divesting the trustee of his discretion with regard to
the investment of plan assets. The Court takes note of the nonimpair-
ment clause of the New York Constitution,8 and concludes that:
To strip this person [trustee], in this instance the State Comptroller, an in-
dependently elected official it so happens, of his personal responsibility and com-
mitment to his oath of office, is to remove a safeguard integral to the scheme of
maintaining the security of the sources of benefits for over a half century . . . But it
is . . . concluded that the Legislature is powerless in the face of the constitu-
tional nonimpairment clause to mandate that he mindlessly invest in whatever
securities they direct. . . .9
The statute the New York Court struck down was a cornerstone of
the New York City MAC financing program of 1975, and a crisis
» 48 Wash. 2d 695. 296 P. 2d 536 (1956).
I Id. at 698, 296 P. 2d at 538.
I Id. at 701, 296 P. 2d at 540.
• 364 Mass. 847, 303 N.E. 2d 320 (1973).
• Mass. Gen. Laws Ann., ch. 32.
• .Supra, note 4, at , 303 N.E. 2d at 328.
» 37 N. V. 2d .507, 337 N.E. 2d 592 (1975).
• N.Y. CONST, art. V, §7.
I Supra, note 7 at 512-13, 337 N.E. 2d at 595.
45
situation was generally thought to exist. As such, Sgaglione v. Levitt
stands as a clear example of a state constitutional provision which
was interpreted to provide a significant level of protection for govern-
mental plan participants.
Act 293, originally enacted by the Pennsylvania legislature in
19 72, 10 stands as an example of a state reporting statute that is de-
signed to permit strict enforcement. The Act requires all municipal
pension systems to retain an actuary for the purpose of periodically
preparing actuarial statements and reports to be riled with the State
Department of Community Affairs. Importantly, the Act contains a
number of enforcement mechanisms. Failure by a municipality to file
such reports results in the withholding from such municipality of any
and all state contributions to the delinquent municipalities' pension
funds.11 The study may also be performed by the state, and the delin-
quent municipality in that instance must reimburse the state for the
cost.12
Act 293 is subject to criticism in that it addresses only actuarial
aspects of the plan. Its substantial enforcement mechanisms, how-
ever, serve to make Act 293 a good example of a state reporting re-
quirement which is designed to achieve the purpose for which it was
presumably enacted.
It must also be noted that in numerous instances state laws which
appear to afford significant protections to pension plan participants
have been interpreted in a manner that demonstrates that protection
to be, in reality, quite limited.
In re. Enrolled Senate Bill 1239 13 stands in direct contrast to
Opinion of the Justices.14" The Michigan legislature sought an advisory
opinion regarding a proposed statutory revision of the public school
employees' retirement system. The statute, for a particular class of
employees, would require an increase, from 3 percent to 5 percent, in
the rate of employee contributions to the plan, with no increase what-
soever in benefits. The Michigan Supreme Court first notes a Michigan
constitutional provision which explicitly states that accrued govern-
mental pension benefits shall represent a contractual obligation which
shall not be impaired or diminished.15 The Court then states:
Under this constitutional limitation the legislature cannot diminish or impair
accrued financial benefits, but we think it may properly attach new conditions
for earning financial benefits which have not yet accrued. Even though compliance
with the new conditions may be necessary in order to obtain the financial benefits
which have accrued, we would not regard this as a diminishment or impairment
of such accrued benefits. » * • M
Thus the Michigan Supreme Court "interprets" the nonimpairment
clause of the State constitution as permitting an increase in the
employee contribution rate, precisely the kind of impairment that the
Massachusetts Supreme Court found unconstitutional in Opinion of
the Justices.
A second example of a state law ' 'protection" that upon testing
was interpreted as not very protective of plan participants is found in
People ex rel. Illinois Federation of Teachers v. Lindberg.17 An Illinois
»» 53 Pa. Stat. Ann. 5 730.1 et seq.
11 53 Pa. Stat. Ann. § 730.4.
a Id.
» 389 Mich. 659, 209 N.W. 2d 200 (1973).
14 Supra, note 4.
>s Mich. CONST, art. 9, § 24.
w Supra, note 13, at 663-64, 209 N.W. 2d at 202-03.
& 60 111. 2d 266, 326 N.E. 2d 749 (1975); cert, denied, 423 U.S. 839 (1975).
46
statute spells out the level of contributions which the state is to make
to each of a number of state retirement systems.18 The Illinois legisla-
ture enacted a series of appropriations measures designed to bring the
state's contributions to these retirement systems nearer the level re-
quired by the statute.
It should also be noted that a provision of the Illinois Constitution
states:
Membership in any pension or retirement system of the State, any unit of
local government or school district, or any agency or instrumentality thereof,
shall be an enforceable contractual relationship, the benefits of which shall not
be diminished or impaired.19
When the governor vetoed or reduced the appropriations bills
designed to more adequately fund the retirement systems at issue,
suit was brought in which it was alleged that the veto and reductions
by the governor violated the impairment of contracts provision of
the Illinois Constitution and the statutory mandate that the state
fund the pension plans at the specified level.
The Illinois Supreme Court first rejects the argument that the
governor's actions violate the state constitutional provision. What-
ever the nature of those contractual rights, the Court indicates,
it cannot be 1 'argued that the provision was intended to restrict the
Governor's constitutional authority to reduce or veto a pension
appropriation measure." 20 The Court then holds that the statutory
material relating to the retirement systems nowhere establishes a
contractual relationship between plan participants and the state or
the plan. 21 Finally, the effect of the statutory funding "mandate"
in terms of the governor's power to reduce or veto appropriations
bills is addressed, and the Court concludes that the funding provi-
sions in no way limit the governor's authority.22
Thus, what appear to be state constitutional and statutory provi-
sions that assure that a plan will be funded at a specified level, upon
judicial interpretation, are found not to assure any such protection
at all.
In conclusion, the benefits and protections that state laws appear
to provide plan participants in some instances are interpreted in a
manner that accomplishes such protections, but in many instances
are found to afford none of the benefits or protections that the state
statutory or constitutional provision at first glance appears to assure..
is 111. Rev. Stat., ch. WVz (1973).
i»Ill. CONST., art. XIII, §5.
20 Supra, note 17 at 272, 32(1 N.E. 2d at 7f)2.
21 Supra, note 17 at 275, 326 N.E. 2d at 753.
22 Supra, note 17 at 277, 326 N.E. 2d at 754-55.
PART IV— CHARACTERISTICS AND OPERATIONS OF
PUBLIC EMPLOYEE RETIREMENT SYSTEMS
Chapter A — Introduction
During the course of legislative activity leading to the September 2,
1974 enactment of ERISA (The Employee Retirement Income
Security Act of 1974 — Public Law 93-406), the Congress amended
early legislative versions of the Act which originally covered govern-
mental pension plans to exclude such plans from provisions relating
to reporting, disclosure, fiduciary, and vesting standards, although
certain Internal Revenue Code provisions were extended to public
pen-ion plans by ERISA. At that time persuasive arguments were
made that the problems encountered by governmental plans were
unique and deserving of additional study. As a result, Section 3031
was added to ERISA:
The Committee on Education and Labor and the Committee
on Ways and Means of the House of Representatives and the
Committee on Finance and the Committee on Labor and Public
Welfare of the Senate shall study retirement plans established
and maintained or financed (directly or indirectly) by the Govern-
ment of the United States, by any State (including the District
of Columbia) or political subdivision thereof, or by any agency or
instrumentality of any of the foregoing. Such study shall include
an analysis of —
(1) the adequacy of existing levels of participation, vest-
ing and financing arrangements,
(2) existing fiduciary standards, and
(3) the necessity for Federal legislation and standards with
respect to such plans. In determining whether any such plan
is adequately financed, each committee shall consider the
necessity for minimum funding standards, as well as the
taxing power of the government maintaining the plan.
EXTENSIVE STUDIES MADE
Extensive research, investigations, and hearings were conducted by
the Subcommittee on Labor Standards — Pension Task Force in dis-
charging this responsibility. Public hearings were held during 1975 in
California, Connecticut, Illinois, and Washington, D.C. These hear-
ings utilized H.R. 9155, a bill extending all of the Title I and IV
standards of ERISA to non-federal governmental plans, as a vehicle
to focus attention on the specific implications of legislated federal
standards.
In the fall of 1975 a census of federal, state, and local government
retirement systems was initiated in an attempt to identify for the
first time the universe of public pension plans. This effort resulted in
the identification of the size and major characteristics of 68 federal
(47)
48
plans and 6,630 state and local government pension plans. The charac-
teristics of the plans included in this inventory were first reported in
the March 31, 1376 Interim Report of Activities of the Pension Task
Force of the Subcommittee on Labor Standards (see Appendix IV
for a complete tabulation of plans by state).
The 22 page questionnaire, 'Tension Task Force Survey of Public
Employee Retirement Systems" (see Appendix II), was sent to a
sample of the PERS universe in order to gather information on public
pension plan administration, benefit structure, finances, and funding.
Between May and September 1976, survey data was obtained on the
pension plans covering 100 percent of the federal government em-
ployees and 96 percent of the state and local government employees
(Appendix I displays the tabular results of the survey data for 1975).
In order to obtain additional information on the investment opera-
tions of state and local government pension funds, the Subcommittee
on Labor Standards — Pension Task Force in conjunction with the
Pension Research Council of the University of Pennsylvania con-
ducted a survey focusing on pension fund investments. Nearly two-
thirds of the public pension funds with assets in excess of $50 million
provided information on statutes, policies, and practices affecting
pension fund investments in 1974-75.
In addition, extensive research was undertaken to record and analyze
the federal, state and local laws affecting public employee retirement
systems (see Parts II and III of this report and Appendices V through
XI).
PERS INFLUENCE VAST AND DIVERSITY GREAT
The various studies carried out by the Pension Task Force thorough-
ly document the nature and scope of the characteristics and opera-
tions of public employee retirement systems. In their entirety, public
employee retirement systems (PERS) exert a substantial influence on
the economic, social, and political fabric of the United States.
The national securities and other capital formation markets are
heavily influenced by state and local government pension fund in-
vestments exceeding $108 billion (1975). Such investments have re-
cently been increasing by 13 percent annually. State and local pension
plan benefit payments ($7.3 billion in 1975) have been increasing even
more rapidly at a rate of 16 percent annually. Federal, state, and
local pension benefit payments add over $21 billion annually to the
consumption and savings elements of the economy. Federal, state,
and local governments must provide for tax revenue exceeding $23
billion annually in order to meet employer obligations to public-
employee pension plans.
The strengths, weaknesses, and diversity of public employee re-
tirement systems are discussed in chapters B through H of this report.
Chapter B discusses some of the general characteristics of the 6,698
federal, state, and local retirement systems (including their relation-
ship to Social Security) which cover 12.7 m ill ion state and local plan
participants and 9.5 million federal plan participants. Chapter C dis-
cusses the serious deficiencies which exist among public pension plans
in the reporting, disclosure, accounting, auditing, recordkeeping, and
other administrative aspects of plan operations.
49
Chapter D discusses public pension plan benefit protections in
relation to ERISA's provisions in the areas of eligibility, vesting,
portability, and plan termination insurance. Chapter E describes the
benefit structure of public pension plans and the extent to which the
combined benefits from public pension plans and Social Security
replace the pre-retirement income of retired public employees.
Chapter F provides information on the finances of public pension
plans and the restrictions which impair the stability and predicta-
bility of employer pension contributions. Chapter G documents the
serious funding problems of mamr public pension plans and the lack
of adequate actuarial valuations, measures, and standards.
In discussing the fiduciary and investment practices of state and
local government pension funds, Chapter H points out that the pres-
ence of various investment restrictions, the absence of adequate dis-
closure and other safeguards, and the lack of fiduciary accountability
all contribute to a high potential for fiduciary abuse and the loss of
pension plan assets and income.
In consideration of the fundamental national interests involved and
the substantial body of federal law and federal involvement in gov-
ernmental pension plans, the facts presented in this report show a
compelling need for a revised and expanded set of federal standards
applicable to federal, state, and local pension plans. Serious conse-
quences are likely unless immediate steps are taken by the federal,
state, and local governments to remedy the serious deficiencies that
exist among the various retirement systems for public employees.
TECHNICAL NOTE
The reader should be careful to distinguish between the PERS
universe of plans given in Appendix IV and the tabular data from the
Pension Task Force Survey of a sample of the plan universe as given
in Appendix I. Appendix III provides an explanation of the survey
methodology. While it was intended that the study include only those
"governmental plans" presently exempted from ERISA (Public Law
93-406), the inclusion of a particular plan in this report or in the
survey should not be taken as proof of such statutory exclusion.
When clarifying regulations are issued, it may in fact be the case that
the same plans now maintaining their exempt status under ERISA,
particularly those of a "quasi-governmental" nature, may be found
to be covered plans.
The data from the Pension Task Force Survey of Public Employee
Retirement Systems in Appendix I is presented in an extremely
detailed format in order that the information be of maximum use-
fulness to plan administrators, public officials, public employees, and
others having an interest in public employee retirement systems.
The data items in the tables of Chapter B through H may not add
to exactly 100.0 percent due to rounding.
ACKNOWLEDGEMENT
This study was a mammoth undertaking and could not have been
accomplished but for the willing cooperation of the many persons who
spent considerable time and effort in supplying the basic survey
50
information. The assistance of the many state and local pension plan
administrators, PERS organizations, and public employee organiza-
tions too numerous to mention individually is gratefully acknowledged.
Special acknowledgement is due to Vance Kane, Chief of the Finan-
cial Branch — Government Division, Bureau of the Census, who pro-
vided the Pension Task Force with the initial data base from which
the expanded universe of state and local pension plans was constructed,
and to the following persons in the Division of Financial and General
Management Studies, U.S. General Accounting Office: Erwin Bedarf
who assisted in developing and testing the Pension Task Force
Survey questionnaire, Herbert R. Martinson and his staff, who were
responsible for the questionnaire sampling and editing process, and
Norman Daley, who produced the required survey tabulations.
Special thanks is extended to Raymond Schmitt of the Education
and Public Welfare Division, Congressional Research Service, who
made important contributions to all phases of the study, and to
Howard Zaritsky of the American Law Division, Congressional
Research Service, who supplied helpful legal assistance and analysis.
Appreciation is also expressed to John Dean and Suzanne Hays of the
Pension Task Force for their support in the preparation of this report.
S. Howaed Kline,
Counsel and Staff Director.
Russell J. Mueller,
Actuary and Minority Legislative Associate.
Chapter B — PERS Universe — General Characteristics
The programs making up the public employee retirement system
(PERS) have been found to be as varied as the pension plans which
make up the private pension system. In 1975 over 6,698 federal, state
and local government retirement systems were identified as covering
15.4 million civilian and military employees. In addition to the 6,698
plans, there are other arrangements made by sponsoring governments
to provide retirement income for their employees. These programs
include deferred compensation contracts, salary reduction plans, and
"tax sheltered" annuities. According to the Institute of Life Insurance,
750,000 individuals were covered and 20,000 persons were receiving
benefits in 1974 under 403(b) tax sheltered annuity plans. It is believed
that at least a majority of the 750,000 persons covered under such
plans were public school teachers and other public employees. The
Employee Retirement Income Security Act of 1974 established
another type of tax deferred pension plan, the Individual Retirement
Account and the Individual Retirement Annuity (IRA), which was
available for the first time in 1975 to all employees working in the
public as well as the private sectors who were not covered under any
other public or private pension plan. It remains to be seen to what
extent pension coverage will be expanded through the use of IRAs to
the approximately 1.5 million public employees not presently covered
under any public plan.
NUMBER AND MEMBERSHIP
The findings of the Pension Task Force as to the total number and
membership of the PERS are summarized in Table Bl. In 1975, 6,630
pension plans of one type or another were identified as being main-
tained by state and local governments for about 10.4 million full- and
part-time workers. Another 2.3 million persons were receiving retire-
ment, disability, or survivors benefits under such plans or were other-
wise eligible to receive benefits at a later date.
TABLE Bl. — NUMBER AND MEMBERSHIP OF PUBLIC EMPLOYEE RETIREMENT SYSTEMS OF FEDERAL, STATE, AND
LOCAL GOVERNMENTS, 1975
Membership (thousands)
Number of
Level of government plans Active Nonactive Total
State and local 6,630 10,387 2,347 12,744
Federal (uniformed services) 4 2, 181 1, 094 3, 275
Federal (nonuniformed services) 64 2,839 3,402 6,241
Total... 6,698 15,417 6,843 22,260
Note: See app. IV for more detail.
(51)
52
Table B2
53
In 1975, the federal government, including its agencies and in-
strumentalities, maintained 68 employee pension plans, the largest
ones being the Military Retirement System (2.1 million active mem-
bers) and the Civil Service Retirement System (2.7 million active
members). The remaining 66 systems have about 183,000 active
members or about 5.6 percent of the total active membership in all
federal plans. The roughly 4.5 million persons presently receiving or
expecting to receive benefits under all 68 federal systems represent
89 percent of the total federal active membership. By way of contrast,
the corresponding inactive to active membership ratio for all state
and local systems is 23 percent. About half of this marked difference
is due to the fact that terminated employees with vested benefits
make up 45 percent of all federal inactives while the corresponding
figure for state and local plans is 11 percent. Some of the causes for
this variation in the number of terminated vested employees are
discussed in the next Chapter. The ratio of inactive to active members
for the federal system is over twice that for the state and local system,
even ignoring terminated vested employees. This demonstrates the
fact that the state and local part of the PERS as a whole has yet to
reach the degree of maturity attained by the federal s}rstem. In this
regard the state and local system is more akin to the private pension
system (see Table Gl2).
The number of state and local plans by size of active membership
is shown in Table B3. One striking similarity with the private pension
system is the large percentage, nearly 80 percent, of all plans with
fewer than 100 active members. At the other extreme are the 390
plans with 1,000 or more active members. While making up less than
6 percent of the total plans, these plans cover about 95 percent of the
active membership in all state and local government pension plans.
TABLE B3.— NUMBER OF STATE AND LOCAL PUBLIC EMPLOYEE RETIREMENT SYSTEMS BY SIZE, 1975
Number of Percentage
plans1 of total
.Size of active membership:
0 to 4 793 13. 7
5 to 24 1,545 26.7
25 to 99 1,110 19.2
100 to 199 332 5. 7
200 to 499 297 5. 1
500 to 999 187 3.2
1,000 to 4,999 206 3.6
5,000 to 9,999 60 1. 0
10,000 and over 124 2. 1
Unknown 2 1, 134 19.6
Total 5,788 100.0
1 Total number of plans exclude 842 plans for which data by type of plan and size of membership is unavailable.
2 Further study revealed that the plans for which acfive membership is unknown are principally local plans for po|icemto
and firemen having fewer than 100 active members.
DEFINED BENEFIT AND DEFINED CONTRIBUTION
Among the 6,698 retirement systems are defined contribution plans
as well as the more typical defined benefit or benefit "formula" plans.
A participant's benefits under a defined contribution plan are based
solely on the amounts contributed to the participant's account and
any income earned thereon. The largest number of similar defined con-
tribution plans are the 314 plans maintained by cities and counties
for their highly mobile managers and administrators. These plans
.are administered by the ICMA Retirement Corporation. At the end
54
of 1974, 605 employees participated in the 314 plans. The next largest
group of similar defined contribution plans are those maintained by
institutions of higher education for faculty and other personnel. In
1975, 294 such plans were in operation (see Table B4) and all the
plans were funded through Teacher Insurance and Annuity Associa-
tion of America and its affiliate, the College Retirement Equities Fund
(TIAA-CREF). In addition to the above, public employees also belong
to a relatively small number of denned contribution plans most of
which are insured and of the money-purchase type.
While only about 2.2 percent of state and local emplo3"ees are mem-
bers of defined contribution plans, nearly 16 percent are covered
under "combination" plans having both defined contribution and
defined benefit features. The bulk of all covered employees, 82 percent,
are members of defined benefit plans providing the more traditional
pay-related and formula calculated benefits. Together, defined benefit
and combination plans comprise over 85 percent of all state and local
plans. With the exception of several small thrift plans and TIAA-
CREF plans, all federal plans are of the defined benefit type. Chapter
E presents extensive information on the varied benefit structures of
both defined benefit and defined contribution plans.
INSURED AND NON-INSURED
The detailed distributions shown in Table 35 of Appendix I reveal
that 27.7 percent of all state and local plans provide some or all re-
tirement benefits through insurance companies (TIAA-CREF is
included in this category). The plans so insured tend to be small,
however, and cover only 4.8 percent of all active employees.
CONTRIBUTORY AND NONCONTRIBUTORY
About 75 percent of the state and local plans surveyed require em-
ployees to make contributions. Most of the plans now "closed" to
new members are or were at one time contributor}7 plans. In total
about 85 percent of all active state and local employees are required
to contribute to their plans. In contrast, about 44 percent of the
federal plans covering 56 percent of all employees require man-
datory contributions.
While the plans for general government employees at the federal,
state, and local level share many common characteristics, the plans
covering the uniformed employees differ in several important respects.
The federal military plans are wholly noncontributory while the plans
at the state and local level covering uniformed employees (police and
fire) are nearly all contributory. This difference may be attributable
to the fact that all members of the federal uniformed services con-
tribute to Social Security while two-thirds of the state and local
uniformed employees do not.
A small but growing number of state and local plans are reducing
or eliminating mandatory employee contributions. Presently, state
employees in Florida, Michigan, Missouri, and New York are included
in the noncontributory category, totaling 21.4 percent of all state
plana and 15 percent of all state employees. For some employees in
New York City and in Wisconsin, governmental employers have
"picked up" a portion of the contributions which would otherwise
have been made by the employees.
55
A few plans give employees the option to either make voluntary
contributions in order to receive retirement benefits or to waive
pension coverage. At the federal level the Vice President, Senators,
Representatives, and congressional employees are given the option to
contribute to the Civil Service Retirement System. At the local level
many plans for volunteer firemen operate on a voluntary basis.
Among the category of contributory plans are 23 or more plans
which provide retirement benefits "supplemental" to basic benefits
paid from other plans maintained at the state or local level. Several
universities maintain supplemental plans which are of the noncon-
tributo y pay-as-3'ou-go type.
PLANS BY JURISDICTION
Over two-thirds of all state and local government retirement
systems are found in the 10 states with the largest number of plans
(see Table B4). With over 1,413 plans, Pennsylvania alone has over
one-fifth of the total plans. Among the top five states and following
Pennsylvania in order are Minnesota (638 plans), Illinois (465 plans),
Oklahoma (435 plans), and Texas (398 plans). By way of contrast to
the decentralized nature of the systems in the majority of states is the
single statewide plan in Hawaii covering all public employees in that
state. While the states with the smallest populations tend to have the
least number of plans, this is not entirety the case. Other states such
as New Mexico (with 4 plans), Ohio (with 7 plans), and Oregon (with
9 plans) have achieved major gains in bringing all public employees
in their respective states under a small manageable number of systems.
Table B4. — Number of Federal, State, and local public employee retirement systems
by State or other jurisdiction, 1975
State or jurisdiction:
(1) Alabama.
(2) Alaska.
Number
of plans 1
47
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(ID
(12)
(13)
(14)
(15)
(16)
(17)
(18)
(19)
(20)
(21)
(22)
(23)
(24)
10
69
72
343
165
13
7
335
54
1
11
4(55
249
75
55
49
62
7
39
103
Michigan 187
Arizona
Arkansas
California
Colorado
Connecticut
Delaware
District of Columbia.
Florida
Georgia
Hawaii
Idaho
Illinois
Indiana
Iowa
Kansas
Kentuckjr
Louisiana
Maine
Maryland
Massachusetts
Minnesota.
(25) Mississippi.
(26) ~
(27)
(28)
(29)
(30)
Missouri.
Montana
Nebraska
Nevada
New Hampshire.
638
23
52
28
52
10
9
Total 6,
1 Total number of plans exclude 539 plans for which data by state Is unarailable.
State or jurisdiction — Con.
(31) New Jersey
New Mexico
New York
North Carolina.
North Dakota..
Ohio
Oklahoma
Oregon.
(32)
(33)
(34)
(35)
(36)
(37)
(38)
(39)
(40)
(41)
(42)
(43)
(44)
(45)
(46)
(47)
(48)
(49)
(50)
(51)
(52)
(53)
(54)
(55)
(56)
Number
of plans 1
39
4
117
58
21
7
__ 435
9
Pennsylvania 1, 413
Rhode Island
South Carolina
South Dakota
Tennessee
Texas
Utah
Vermont
Virginia
Washington
West Virginia
Wisconsin
Wj^oming
Puerto Rico
Virgin Islands
Guam
Washington Metropoli-
tan Area Transit Au-
thority
Federal
22
13
7
27
398
12
31
28
53
69
46
8
5
1
1
1
68
159
56
Pension plans covering every imaginable description of public em-
ployment are found at all governmental levels. In size, they range
from the 417,000 member New York State Employees' Retirement
System, which is the largest system at the state and local level, to the
Evergreen Park, Illinois Firemen's Pension Fund, which at the time
the census was taken did not have an}' active members. The Wash-
ington Metropolitan Area Transit Authority (better known as
METRO) was found to be a "body corporate and politic" and its
unique 1,000 member system is included in the "special district"
category (52) as shown in Table B5. Some other systems which cover
unique categories of workers are the Central Intelligence Agency
Employees Voluntary Investment Program, the TIAA-CREF Re-
tirement Plan for Faculty Members of the Uniformed Services
University of the Health Sciences, the YVaterford (California) Ir-
rigation District Pension Plan, the Dekalb County, Alabama Hos-
pital Annuity and Benefit Plan, the Salt River Project Agricul-
tural Improvement Power District Retirement Plan (Arizona),
and the State of South Dakota ( 'ement Plant Pension Plan.
ADMINISTRATION AND COVERAGE CATEGORIES
Generally, public emplo}'ee retirement systems may be categorized
by level of administration — that is, at the federal, state, city, county,
township (borrough), or special district level. As shown in Table B5,
over 80 percent of the plans are administered at the city and township
levels, while the state governments administer 9.6 percent of the total
plans. Plans covering either policemen or firemen exclusively make
up two-thirds of all plans. While 68 plans have been categorized as
being "teacher plans," teachers in 21 states participate in a statewide
system covering state employees as well as teachers. In most states
judges are covered under separate retirement plans while legislators
in seven states have separate systems.
TABLE B5.— PUBLIC EMPLOYEE RETIREMENT SYSTEMS OF STATE AND LOCAL GOVERNMENTS BY TYPE OF
ADMINISTERING GOVERNMENT, 1975
Number
Level of administration of plans 1 Percent
STATEWIDE PLANS
1. State employees only 30 5.4
2. State employees plus local government employees (including teachers) . 43 7.8
3. Police only 31 5.6
4. Fire only 13 2.3
5. Police and fire only 8 1.4
6. Teachers 35 6.3
7. Legislators 8 1.4
8. Judges 41 7.4
9. Local government employees (excluding teachers)... 22 4.0
10. Local government employees (including teachers) 0 .0
11. Faculty and others (TIAA-CREF only) 234 53.1
12. Faculty and others (other than TIAA-CREF) 13 2.3
13. All other statewide plans 16 2. 9
Totsl (9.6 percent of all plans) : 554 100.0
CITY PLANS
21. City employees only (excluding teachers) 445 12.9
22. Citv employees only (including teachers) 5 .1
23. Police only 940 27.3
24. Fire only. 1,710 49.7
25. Police and fire only 276 8.0
26. Teachers 23 .7
27. Judges ' 2 .1
28. All other city-adrnmisteied plans 1 40 1.2
Tot3l (59.5 percent of all plans) . 3,441 100.0
See footnotes at end of table.
57
TA8LE B5.— PUBLIC EMPLOYEE RETIREMENT SYSTEMS OF STATE AND LOCAL GOVERNMENTS BY TYPE OF
ADMINISTERING GOVERNMENT, 1975— Continued
Number
Level of administration of plans* Percent.
COUNTY PLANS
31. County employees only (excluding teachers)...
32. County employees only (including teachers)
33. Police only
34. Fire only.
35. Police and fire only
36. Teachers
37. Judges
38. All other county-administered plans
Total (4.6 percent of all plans)
TOWNSHIP PLANS
41. Township employees only (excluding teachers)
42. Police only
43. Fire only
44. Police and fire only
45. All other township-administered plans
Total (22.6 percent of all plans).
SPECIAL DISTRICT AND OTHER PLANS
51. Teachers
52. All other (e.g., transit authorities)
Total (3.8 percent of all plans)
ALL PLANS
Police (3)-K23)+(33)+(42)
Fire (4)+(24)+(34)+(43)
Police and fire (5)+(25)+(35)+(44)
Teachers (6)+(26)+(36)+(51)
Faculty and others (11)+(12)
Legislators (7)
Judges (8)+(27)+<37)____
State (i)+(2)+ (13)
Local (9)+(10)+(21)+(22)+(28)+(31)+(32)+(38)+(41)+(45).....
Other (52)
Total State, and local government plans.
1 Ol
181
C7 C
b/. b
3
1.1
29
10.8
22
8.2
3
1. L
7
2.6
4
1. 5
19
7.1
258
100.0
AT3
1/i
00. L
779
lie
KQ 1
04
0 C
L. 0
y
7
. /
iy
I. 4
1, 3U/
1UU. U
3
1.4
215
98.6
218
100. 0
1,772
30.6
1,779
30.7
2S5
5.1
68
1.2
307
5.3
8
.1
47
.8
89
1.5
1,208
20 9
215
3.7
5,788
100. 0
1 Total number of plans excludes 842 plans for which data by level of administration is unavailable.
While police and fire plans constitute nearly two-thirds of the
PERS plan universe, Table B6 shows that the employees in the police
and fire category make up only 6.7 percent of all covered employees.
The teacher category is the largest with 30 percent of all covered
employees. State employees make up 22.8 percent, and local govern-
ment employees make up 26.7 percent of the total coverage. Employees
of transportation, utility, and other quasi-governmental organizations
form a significant 9.7 percent of the total number of covered workers.
Although the split between the number of full-time and part-time
employees was unavailable for many of the plans surveyed (see
Appendix I, Table 14), it remains that a significant proportion of
covered part-time workers are volunteer firemen (Table B6 shows
24.1 percent to be in this category). The teacher category makes up
26.9 percent of the total part-time coverage, while the state and the
local employee categories constitute 1.7 percent and 8.8 percent
respectively. The large percentage difference between the teacher
category and the state and local categories is probably due to the
larger absolute number of part-time teachers, the less restrictive plan
eligibility requirements for part-time teachers, and perhaps a greater
understatement of the number of part-time employees in the state
and local categories.
58
TABLE B6. — DISTRIBUTION OF RETIREMENT SYSTEM ACTIVE EMPLOYEES BY EMPLOYMENT CATEGORY
Percent of employees
Less than
Full-time full-time
Employee category employees employees Total
State and local totals:
Federal .2 . 1
Stats 24.6 1.7 22.8
Local J 28.7 8.8 26.7
Police and fire 6.9 24.1 6.7
Teachers 28.5 26.9 30.0
Teaci-.ars (higher education) 3.4 3.9 3.9
Other. 7.6 34.5 9.7
Tota! 100.0 100.0 100.0
Note: Data relates to table 14 in app. I.
SINGLE AND MULTIPLE EMPLOYER PLANS
As might be expected nearly all of the smaller state and local
public pension plans are maintained by a single employing unit of
government (see Appendix I, Table 5). However, over 40 percent of
both the federal plans and the largest state and local plans are main-
tained by multiple governmental units. Additional characteristics
exhibited by "multiple employer" plans are discussed in the next
chapter.
SOCIAL SECURITY COVERAGE
In 1975 45 percent of the employees in plans maintained by the
federal government and its agencies and instrumentalities were
covered under Social Security. The Military Retirement System with
2.1 million employees is the largest public system providing benefits
supplemental to Social Security. Among the other federal retirement
systems serving to supplement Social Security are the Federal Re-
serve Bank Plan, the Tennessee Valley Authority Plan, the Federal
Home Loan Bank Plans, the Farm Credit District Plans, and the
Nonappropriated Fund Plan (see Table B2). The 2.7 million employees
contributing to the Civil Service Retirement System make up the
largest single group of employees presently excluded from Social
Security. Also excluded are the President, Vice President, Senators,
Representatives, and federal judges. In total about 55 percent of the
employees in federal plans are excluded from Social Security.
Compared with the federal participation, a larger percentage
(70.1 percent) of state and local employees in staff retirement systems
are covered under Social Security. Table B7 shows that state and local
employees working full time are twice as likely to be covered under
Social Security as are part-time workers. While nearly 85 percent of all
state employees have Social Security coverage, only 36.4 percent of the
members in police and fire plans have such coverage. Teachers are less
likely to be covered under Social Security, 56.5 percent, than are other
local government employees, 75.9 percent. University faculty are as
likely to have Social Security coverage, 83.8 percent, as are other
state employees.
59
TABLE B7.— PERCENTAGE OF ACTIVE EMPLOYEES COVERED BY SOCIAL SECURITY
Percent of employees
Less than
Full-time full-time
Employee category employees employees Total
Federal plans 46.8 .8 45.4
State and local pians:
State 84.9 18.1 84.9
Local 76.0 100.0 75.9
Police and fire... 37.2 22.2 36.4
Teachers 62.6 40.6 56.5
Teachers (higher education).. 85.9 30.5 83.8
Other. 78.2 10.2 86.6
Total 72.2 31.5 70.1
Note: Data relates to table 14 in app. I.
There are many important issues arising from the coverage or
noncoverage of public employees under Social Security. These issues
include universal Social Security coverage, the "integration" of public
pensions with Social Security, and pension portability (see Appendix
XIII for a comprehensive bibliography on these topics) .
PENSION COVERAGE NOT UNIVERSAL
The information in the preceding section is based on those public
employee retirement systems included in the Pension Task Force
Survey. Not all public employees, however, are covered under a
pension plan. The Bureau of the Census reported that in October
1975 about 12.1 million persons were employed by state and local
governments on a full or part-time basis. Since 10.3 million employees
were reported as having pension coverage in the PTF survey, between
1 and 2 million public employees remain without pension coverage.
This finding is consistent with that from the 1972 Census of Govern-
ments in which approximately 11 percent of all full-time public em-
ployees were shown to have no pension plan coverage (see Table B8) .
However, about 78 percent of those full-time employees without pen-
sion coverage were shown to have Social Security coverage. A higher
percentage of part-time employees, probably more than 50 percent,
do not have pension coverage. (See Chapter D for more information
on pension plan eligibility provisions excluding part-time employees.)
74-365—78 5
Chapter C — Pers Administration, Keporting, and Disclosure
The Pension Task Force survey documents the wide variation in
administrative and operational practices found in the public employee
retirement system (PERS). This study is not the first to find public
pension plan administration and the reporting and disclosure of plan
operations to be nonuniform and, in many cases, inadequate.1 One
expert on municipal finance has observed that "high on the list of
reason for long inattention to pension matters is the paucity of useful
information about the status of most jurisdictions' pension systems".2
This Chapter discusses the development of the public employee
retirement system and the fact that the PERS has generally evolved
in the absence of an overall policy framework. It also discusses retire-
ment system administration, the wide variations in pension plan
control, the infrequency of routine audits of public plans, and short-
comings in disclosing important plan information to participants and
beneficiaries. Lastly, this Chapter discusses the general state of
confusion surrounding the qualification of public pension plans under
the Internal Revenue Code, as well as certain deficiencies noted iu
recordkeeping and other procedures.
PERS DEVELOPMENT AND CONSOLIDATION
The development of the public employee retirement system began
earlier than the private system. In 1857 New York State passed a law
providing lump sum benefits to New York City policemen injured in
the line of duty. It took another 21 years before the city's policemen
were able to retire without proof of incapacitation — half final pay at
age 55 with 21 years of service.3 Even before the 1900's, groups of
policemen, firemen, and teachers were covered under service-related
retirement systems in New York, Boston, and other cities. Over 12
percent of the largest State and local plans in current operation were
established before 1930 (see Appendix I, Table 2). The federal system
follows a similar pattern with service-related pensions for military
personnel having first been paid in 1861 followed by the establishment
of the Civil Service Retirement System in 1920 for civilian personnel.
The number of large public plans increased dramatically during the
period just prior to the enactment of Social Security legislation in 1935
but before optional coverage was afforded state and local government
employees. Nearly one-half of the largest state and local plans were
established during the period 1931 to 1950 when Social Security
1 For example, see California's Public Pension System: An Interim Report to the California Legislature by
the Senate Subcommittee on the Investment of Public Funds (Senator Alan Bobbins, Chairman), Novem-
ber 1974; and Florida's Local Retirement, Systems: A Survey, published annually by the Florida Depart-
ment of Administration, Division of Retirement.
2 Evaluating the Fiscal Significance of Public Pension Liabilities: Some Suggestions for Municipal Credit
Analysts, by Dr. Bernard Jump. Jr., prepared for presentation at the Public Securities Association Public
Finance Conference, Marco Island, Florida, October 6, 1977.
3 Tilove, Robert. Public Employee Pension Funds. A Twentieth Century Fund Report. Columbia
"University Press, New York and London, 1976. pp. 261-282.
(61)
62
coverage for public employees was being debated. Over one-third of the
largest plans were started or restructured in a major way after 1950
when state and local employees were extended the option to join
Social Security. In contrast nearly two-thirds of the small plans were
started after 1950; nearly one-fourth since 1970. (Data showing the
dynamics and continuing development of the PERS are presented in
Tables 3 and 4 of Appendix I.)
Over 40 percent of the larger state and local plans have increased
their scope of operations in the past b}^ adding new employee groups
to their coverage. The period since 1970 has been most active one
with over one-fifth of all plan "absorptions" having taken place in
this period. Considering this trend to consolidate smaller plans into
larger ones, it follows that the public plan universe may have been
significantly larger only a decade ago.
When old plans are restructured or consolidated, membership is
usually closed and new hires covered under the new plan. Such
"closed" plans now make up about 6 percent of the public plan
universe.
Sometimes the reverse of plan consolidation occurs among public
pension plans. Nationwide 3.4 percent of the largest local plans now
in operation were at one time part of an even larger local or statewide
system. In some state-administered plans, such as the Penns3dvania
Municipal Employees Retirement System, local employee units have
the option to withdraw from the system and on occasion have done so.
Many new plans have consolidated operations in an attempt to
rationalize benefit policy and to gain expertise and efficiencies in plan
management, accounting, actuarial, computer, and investment func-
tions. Plan consolidation has resulted in administrative savings and
proved beneficial in some cases, but there can be barriers as well as
some disadvantages to consolidation.4 The creation of one large plan
covering many different groups of employers has by no means proved
to be a panacea for all public pension plan problems.5
The issues surrounding the consolidation of plans for two or more
different groups of public employees are complex. Consolidation
usually results in what might be called a "multiple employer" pension
plan which can take many different forms. The Civil Service Retire-
ment System is a multiple employer plan covering the various Federal
agencies with a unique aspect being that a local government em-
ployer— the District of Columbia — contributes to the plan on behalf
of its general government employees.
For purposes of the Pension Task Force survey, a plan being
administered in most respects on a separate basis was not considered
a multiple employer plan merely because plan assets were com-
mingled with the assets of other plans for investment purposes (e.g.,
the Illinois General Assembly, Judges, and State Employees' Retire-
ment System pension funds are managed by the Illinois State board
of Investment, yet each fund was considered a separate "plan" in
the survey). On the other hand, a centrally-administered system was
« Many of the advantages and disadvantages of consolidating are given in: Retirement System Consolidation:
The South Dakota Experience, by James Jarrett and James E. Jlicks, The Council of State Governments,
Lexington, Kentucky, November 1976.
I For example, see the Commonwealth of Pennsylvania State Employees Retirement System Auditor General
Report of Examination for the period June, 1973 to December SI, 1974, (including press release); see also an
article on the same system in the Wednesday, June 6, TJ73 issue of the Irwin Standard Observer, p. 8.
63
considered to be a multiple employer plan even though all financial,
actuarial, contribution, and other plan aspects were accounted for
separately for each contributing employer (e.g., the Missouri Local
Employees Retirement System). See Table Cl for the distribution
of single and multiple employer pension plans and the accounting
treatment of plan finances under multiple employer plans.
TABLE Cl.— ACCOUNTING TREATMENT OF SYSTEM ASSETS, LIABILITIES, RECEIPTS, AND DISBURSEMENTS FOR
SINGLE AND MULTIPLE EMPLOYER RETIREMENT SYSTEMS
[In percent of plans)
More than 1 contributing employer
Separate
accounting
for each
employer;
assets
allocated
so as not
to pay
Accounting Separate benefits to Multiple
Single on a accounting employees employer
contributing planwide for each of other plans
System category employer basis only employer employers subtotal Total
I. Federal Government 58.2 21.8 9.1 10.9 41.8 100
State and local government:
II. By size of system:
A. Large 58. 7 26. 1 6. 0 9. 2 41. 3 100
B. Medium 91.9 2.7 4.2 1.2 8.1 100
C. Small 97.2 2.1 .7 2.8 100
Total 93.5 4.0 1.1 1.4 6.5 100
Note: Data relates to tables 5 and 6 in app. I.
PUBLIC PENSION POLICY
With notable exception, most jurisdictions, at all government
levels, have not developed an overall policy framework to serve as a
guide for dealing with public pension issues. There are many reasons
for this shortcoming. Historically, the PERS has taken shape through
the addition of a patchwork of laws and programs, creating complexity
and confusion. In addition, the specialized nature of pension operations
often requires those setting policy to have a technical knowledge of
accounting, actuarial, and investment concepts. There is little doubt
as to the reasons why public officials and the public at large have in
the past been less than enthusiastic in wading into the public pension
morass.
A unique aspect of the public sector in dealing with pension matters,
is the reluctance or inability of one legislature or administration to
commit its successors to a particular policy or course of action (beyond
whatever "policy" is inherent in applicable laws). The lack of a public
pension policy and its ultimate effects on pension program
evolvement was a topic discussed in a speech of state Representative
Dan Angel of Michigan delivered before the National Seminar on
Pension Issues in Washington, D.C. on September 15, 1977.
Right now we have what amounts to a porkbarrel and piecemeal approach
to pension modification. We modify one system without regard for fiscal conse-
quences and then other systems want the same. This takes place in a totally poli-
64
tical atmosphere without any regard for how the bill will be paid, by whom, and
when. There is a total absence of logical structure. Employees had better get
concerned that there is enough cash on hand to meet retirement needs and tax-
payers had better get concerned with these massive and increasing debt obliga-
tions. We simply cannot continue in this helter-skelter fashion.
Some states have formed retirement commissions to enable legis-
latures and administrations to deal with pension matters more
effectively on a long-range basis. Ten states have formed permanent
retirement commissions while other states and the federal government
have from time-to-time created temporary retirement commissions.6
Retirement Commissions have had varying degrees of success in
dealing with the pension problems giving rise to their establishment.7
Just identifying the problems can be a major task. The Pension Task
Force found that states with retirement commissions were more
likely to have catalogued information on the plans operating within
their jurisdictions than other states, many of which were found to
have little knowledge of the number and types of plans operating
within their boundaries.
Generally, retirement commissions set goals 8 which are intended to
meet public pension problems such as those documented by the
Pension Task Force survey — e.g., the lack of meaningful financial
and benefit disclosure; the lack of auditing and actuarial standards
and reports; inequitable benefit structures; rapidly escalating pension
costs resulting from inadequate past levels of funding; and the com-
plexity and confusion caused by divided pension responsibilities
among different jurisdictions and between different agencies or
branches of the same jurisdiction.
This problem does not exist just at the state and local level. In an
August 3, 1977 General Accounting Office Report to the Congress,
the Comptroller General had the following to say about the federal
retirement systems:
The Congress has not provided an overall policy to guide the development of
federal retirement systems and should do so. Centralization of committee juris-
diction over all federal employee retirement systems would facilitate the estab-
lishment and implementation of such a policy. The systems have developed on an
independent, piecemeal basis, causing inequities and inconsistencies, as well as
common problems. Many of the differences are without apparent explanation.
6 States with permanent retirement commissions as of December 1976 are Illinois, Louisiana, Massachu-
setts, Minnesota, New York, Ohio, South Carolina, South Dakota, Tennessee, and Wisconsin. More
information is contained in Permanent Legislative Retirement Commissions, published by the Special
Subcommittee to Study Michigan's Retirement System of the Michigan House of Representatives Com-
mittee on Retirement, December 1976. At the federal level, President Carter created the President's
Commission on Military Compensation on June 27, 1977 and announced in June 1977 that he was going to
create a Presidential Retirement Commission to study private and public pension issues.
7 For example, see the recommendations made in the 1973 Report of the Illinois Public Employees Pension
Laws Commission.
* For example, the following pension reform principles were adopted in 1977 by the National Conference
pf State Legislatures' Task Force on Public Pensions:
I. Creation of permanent legislative commissions with staff and actuarial assistance with responsi-
bility for recommending legislative changes.
i . Requiring all public funds to report annually to the legislatures on a uniform basis.
3. Prohibiting changes in pension benefits or contributions by any body other than the state
legislature.
4. Statutorily prohibiting collective bargaitiing on public pensions.
p. Imposing a moratorium on any reduction in the age of retirement.
6. Requiring competent fiscal notes on all proposed pension legislation.
7. Eliminating pension-hopping and double-dipping.
8. Consolidating state and local government pension systems into one plan.
9. Periodic re-examination of disability roles.
10. Requiring legislation which would increase pension benefits to also contain front-end funding on
a sound actuarial basis.
II. Integrating all state and local systems with social security (since the taxpayer is the basic employer
of any government pension system).
65
RETIREMENT SYSTEM ADMINISTRATION
While the survej^ data show that larger plans are generally better
managed than smaller plans, in man3r cases larger plans display the
same administrative weaknesses as smaller plans. In addition, large
multiple emplo}rer plans have been found to have some unique problems
of their own. The survey data supplements the findings of a state
official who discovered municipal pension S3^stems in one state to be
"in a primitive and discordant state".9
With rare exception, the administrative responsibility for large
public employee retirement S3^stems is vested in a retirement board
(board of trustees, investment board, etc.). Generally, retirement
boards are established under provision of law and are, therefore,
responsible to legislative bodies or elected officials. In contrast, plan
administration in nearly one-third of all smaller state and local
pension plans is carried out under the offices of elected public officials.
These officials may in some cases turn over administrative duties to
persons outside government.
The extent to which control over pension policy is delegated by
statute to a retirement board varies from system to system. In some
large systems, retirement boards make legislative recommendations,
set investment polic}* , establish rules of benefit entitlement, review or
approve administrative budgets, and hire inside staff and outside
consultants to cany out day-to-day operations. At the other extreme,
retirement boards may be established only to review disability and
retirement claims. In some cases legislative bodies may retain close
control over administrative budgets through the appropriation process
but delegate investment and other administrative functions to govern-
mental departments or offices different from the retirement board.
Large city and state systems with broad administrative powers
usually appoint a full-time executive director (plan administrator) to
guide the board and to carry out such duties as the board may delegate.
As shown in Table C2, 36 percent of the smallest plans and 21.2
percent of the medium sized plans do not have retirement or invest-
ment boards. In these smaller plans, city clerks, budget officers, even
police chiefs may spend part of their time on pension plan administra-
tion and investment matters. Consultants, insurance agents, or in-
surance companies perform some or all of the administrative services
for a majority of the smaller plans not havmg retirement boards.
6 Hearing before the Subcommittee on Labor Standards of the Committee on Education and Labor,
94th Congress, 1st Session, on H.R. 9155, Washington, D.C., September 17, 1975, testimony of William H.
Wilcox, Secretary, Pennsylvania Department of Community Affairs, p. 70.
66
TABLE C2.— RETIREMENT SYSTEM ADMINISTRATION
Ultimate policy and administration authority
vested in (percent of plans)
plans having —
Neither a
retirement or
Retirement Investment investment
System category board board board
1. Federal Government
43.7
9.1
54.6
State and local government:
II. By size of system:
A. Large. ...
88. 5
10.1
11.0
B. Medium
78. 2
5.6
21.2
C. Small
64. 0
.7
36.0
Total
67. 9
2.1
32.0
Note: Data relates to table 7 in app. I.
One of the duties for about one-fifth of all retirement boards is to
serve as the custodian of plan assets. Individual board members in
5.6 percent of all plans serve in this capacity. The role of custodian
is given to the plan administrator in 3.3 percent of all plans. In
23.5 percent of all plans insurance companies receive plan contribu-
tions and invest plan assets. For the largest number of plans, 42
percent of the total, the treasurer of the related governmental body
serves as custodian. Banks and trust companies are assigned custodial
duties in 21.4 percent of all plans (see Table 9 of Appendix I).
Regardless of their composition, most retirement boards exercise
full authority in investing plan assets (subject to applicable law as
discussed elsewhere in this report). Increasingly, retirement boards
have been turning to both in-house and outside professional advice
and management in the investment area. As shown in Table C2,
over 10 percent of the larger plans, mainly at the state level, now
turn all investment functions over to unified investment boards.
Among other states, Illinois, Minnesota, and Wisconsin have estab-
lished separate investments boards at the state level.
The effectiveness and sensitivity with which a retirement board
can deal with complex administrative and investment issues is depend-
ent on the interest, experience, and abilities of its individual members.
Detailed insight into the characteristics and composition of retire-
ment boards can be obtained by referring to Table 8 of Appendix L
This table shows that employee representatives constitute a board
majority in about one third of all federal, state, and local systems.
On the other hand, employees have no board representation in 28
percent of the plans. The retirement boards for small plans and
local plans are more likely to have employee majorities than are large
state plans. This is partly accounted for by the fact that police and
fire plans having employee board majorities in nearly 40 percent of
the cases make up a large percentage of small local plans.
Employee board representatives are more than three times as likely
to obtain their board position through an election process than by
appointment. Employee representatives are elected by other plan
participants in about 83 percent of the local plans but in only half
that percentage of state plans.
67
In another one-third of all systems, elected and non-elected govern-
ment officials control plan administration through collective board
majorities. There is a sharp contrast between state and local plans
in this regard. Governmental officials have board majorities in about
37 percent of the local plans while obtaining majorities in only 14
percent of the state plans. In the vast majority of cases, government
officials achieve board membership on an ex officio basis. Only in a
small percentage of plans are they elected by plan members. In about
one-fifth of all plans, retirement boards have been established without
any representation on the part of elected or other government officials.
An important difference between state and local plans is the large
percentage — nearly 23 percent — of state plans having retirement
board majorities consisting of persons employed outside of government
in fields unrelated to investment or finance. The comparable per-
centage for local plans is 2.7 percent. Board membership for such
persons is usually attained by appointment. On the other hand, less
than 1 percent of all retirement system boards have members who
are persons employed outside of government in fields related to the
investment, banking, or finance field.
As diligent as some administrators have been in fulfilling their
duties, the lack of clear-cut pension policies, direction, and control
(discussed in earlier sections) has prevented some systems from
overcoming certain administrative weaknesses. This has been most
apparent in the administration of the disability programs of some
systems, large and small.
Systems having similar service and disability retirement provisions
covering employees of the same occupation show wide variations in
the relative number of disabilities granted.
On a national basis the number of disability retirees in the police
and fire category as a percentage of all retirees is about 23 percent.
Yet for large similarly situated police and fire plans this ratio ranges
from less than 10 percent to over 80 percent. A large share of such
variation which cannot be attributed to different definitions, environ-
ment, etc. results from varying degrees of what might be described
as administrative largess. Administrative laxity in the disability
area has forced at least one plan in the past into court appointed
receivership.10 Small plans can be particularly vulnerable to abuse in
this area.
State-run plans generally exhibit lower ratios of disableds to total
retireds than do city-run plans. The overall ratio for plans in the
state and local government category is 8.5 percent as compared with
a ratio of 26 percent for the federal Civil Service Retirement System.
While the definition of disability for the federal system is more
liberal than that for many state and local plans, a part of the 213
percent difference is undoubtedly due to differing administrative
procedures.11
The seriousness of the equity and cost implications of inadequate
administration in the disability area has begun to be recognized in at
least some federal, state, and local systems.12
10 See New York Times, March 1, 1972, "Hudson County New Jersey Plan Put Into Receivership."
11 Report to the Congress by the Comptroller General of the United States, Civil Service Disability Retirements:
deeded Improvements, November 19, 1976.
12 For example, see Report No. 94-1728, 94th Congress, 2nd Session, September 29, 1976, on the District of
Columbia Retirement Reform Act, p. 9-11.
68
In other benefit areas, administrative procedures have proved in-
adequate to prevent certain benefit provisions from resulting in
favoritism, other inequities, and abuse. Over one-fourth of all public
plans calculate pension benefits on base pay plus overtime pay during
the last year (or last day) before retirement. The manipulative pay
and personnel practices used to achieve larger benefits under plans
with such provisions are well-known.13 Less attention has been paid
to another provision of some public plans which gives part-time em-
ployees the same service credit as full-time employees. A part-time
employee can then receive the same pension as a full-time employee
with the same service by being allowed to work full-time for the final
3 or 5 years before retirement (the period used for computing benefits) .
For this and other reasons many public plans were unable to distin-
guish between part-time and full-time members for survey purposes
(see footnote to Table 14 of Appendix I).
The task of the public pension plan "administrator" is a difficult
one given the number of different parties exercising direction, control ,
and influence over public pension matters. The time and attention of
the plan administrator is demanded by legislative bodies, elected
officials, various boards and commissions, employee representatives,
and other special interests. Even where one person is given the title
of plan administrator, as is the case for most large plans, plan admini-
strative functions (including investment ones) may be carried out by
persons working in private or public capacities under various offices,
departments, agencies, boards, or institutions.
The answers administrative personnel give to the question "Who
has ultimate plan control?" are instructive and lend insight into the
special nature of governmental plans. The ultimate authority in dif-
ferent cases may reside in the mayor, the city council, the board of
education, the police or fire commission, the governor, the state
legislature, retirement or investment boards, the U.S. Congress, or
even collective bargaining agreements. For the most part, but not in
all cases, federal, state, and local statutes or codes govern the estab-
lishment and operation of public plans. To the extent such laws do
not exist or are less specific in their requirements, the form and struc-
ture of plan axlministration is left to the discretion of those responsible
for administering the plan.
The controls over 'pension plan administration, whether by law or
otherwise, are complex and confusing and have proved inadequate in
some cases. Some very small pension plans have a retirement board
with more members than the number of participants in the plan.14 A
lack of adequate control leads to abuses, such as occured in one com-
munity having four police chiefs in six days in order to entitle the
officers to higher pension benefits.15 Pension plans administered with-
out the benefit of statute or even written plan documents are an open
invitation to abuse.16
'3 For example, see Hearing before the Subcommittee on Labor Standards of the Committee on Education
and Labor, 'J4th Congress, 1st Session, on H.R. 9155, p. 70; also see The. Evening News, Harrislmrg,
Pennsylvania, October 13, 1976, "40 Cities Face Agony on Pension-fund Handling." Also see New York
Times, July 27, 1975, "New York City Transit Workers Increased Benefits Because of Overtime."
i* Report of the Illinois Public Fmployees Pension Laws Commission, 1973, page 17.
"Hearing before the Subcommittee on Labor Standards of the Committee on Education And Labor,
94th Congress, 1st Session, on H.R. 9155, Washington, D.C., September J7, 1975, testimony of William H.
Wilcox, Secretary, Pennsylvania Department of Community Affairs, p. 70.
« Ibid., p. 73.
69
While the absence of specific legal requirements pertaining to
pension administration may leave open certain avenues leading to
manipulation and abuse, a maze of laws built up over time may add
another form of conflict or confusion. For example, in one state "the
provisions . . . have become so vague and confusing that ad-
ministrators of the various systems must select one of a variety of
interpretations and hope they are right." 17 In other states, the state
legislature may increase benefits for local employees while leaving to
the local jurisdictions the job of raising revenues to finance the new
benefits. A chaotic condition can result when local jurisdictions cannot
raise the necessary revenues because of state laws placing a limit on
local rates of taxation.18 Local jurisdictions can also be placed in a
state of financial uncertainty when state laws stipulate contribution
rates which prove inadequate.19
Recognizing the confusion and conflict that a patchwork of laws
can create, several states have taken steps to provide greater uni-
formity and control over pension matters.20 However, increased State
control has not necessarily solved all the financial and administrative
difficulties found in those states. Even where some States have ex-
perienced greater control, rising pension outlays and swelling pension
liabilities continue to reflect inadequate pension funding in many
States.21 In addition, rarely do the states retain control over practices
which have great effect on pension costs such as salary (for final
average pay plans), personnel practices (e.g., granting overtime), and
collective bargaining (now extending to about 35 percent of all em-
ployees covered under 22 percent of all plans).22
RETIREMENT SYSTEM AUDITS
The most striking characteristic of public employee retirement
system audits is the absence of any uniform or standard auditing
practice. About 4.6 percent of all state and local plans and 29.1 percent
of all federal plans are not audited at all (see Table C3).
A substantial segment of the public employee retirement system is
characterized by the absence of any regular or external independent
review of plan operations. Nearly one-third of all state and local plans
and 37 percent of the larger ones do not provide for annual audits.
Only 47.4 percent of all plans and 38.9 percent of the larger ones are
audited annually by licensed or certified public accountants outside of
government. Another 10.8 percent of all plans are audited by inde-
pendent accountants, but not on an annual basis.
17 Recommendations For Action on Local Retirement Plans, State of Michigan Department of Management
and Budget, Office of Intergovernmental Relations, May 1977, p. 7; another example of differing interpre-
tations of state law regarding benefits is in Pennsylvania Department of Community Affairs Reports, Mav
1976. article by Conrad M. Siegel, p. 2.
18 Hearing before the Subcommittee on Labor Standards of the Committee on Education and Labor,
94th Congress, 1st Session, on II. R. 9155, Washington, D.C., September 17, 1975, testimony of William H.
Wilcox, Secretary, Pennsylvania Department of Community Affairs, p. 64.
19 Denver Post, December 8, 1976, "Englewood Sues State Over 'Unsound' Pension Law."
20 Among others, most of the states with permanent retirement commissions (listed in footnote 6) have
tak'm steps at the state level to achieve greater uniformity and control over state and local pension matters.
21 Illinois and Massachusetts are only two states where retirement commissions have called attention to
the need for increased pension contributions to budget and finance pension costs on a current basis.
22 For example, a city participating in one statewide system attempted, in this case unsuccessfully, to
permit employees to convert insurance and other city paid benefits to "income" for the purpose of boosting
pensions by as much as 20 percent. See Pensions & Investments, February 28, 1977, "Madison Loses Rebate
Money for Trying to Boost Employees' Incomes," p. 10.
70
TABLE C3 — EXTENT OF RETIREMENT SYSTEM AUDITS
Percent of plans
Audited, but not
Audited every year annually
Not Outside Outside
System category audited audit Total audit Total Other Total
I. Federal Government 29.1 40.0 50.9 1.8 5.5 14.5 100
State and local government:
II. By size of system:
A. Large 1.3 38.9 63.0 11.3 32.4 3.3 100
B. Medium 7.3 34.6 51.4 16.7 30.7 10.6 100
C. Small 4.4 50.7 70.6 9.6 18.4 6.6 100
Total.... 4.6 47.4 67.0 10.8 21.4 7.0 100
Note: Data relates to table 11 in app. I.
Characteristic responses for the plans shown as "other" in Table
C3 were: "audited once in 13 years by CPA firm", "last audit by
state was in 1971", and "funded by insurance". The remainder of the
plans not previously discussed are audited periodically by agencies of
federal, state, or local governments. About 45 percent of the largest
plans and 30 percent of all plans fall into this category. Some of the
largest public pension plans in the country are only audited every
4 or 5 years, and they are audited at that time by related governmental
agencies.
Some pension experts have questioned the appropriateness and
adequacy of public pension p]an audits by related governmental
agencies. The executive secretary of one large state system had the
following to say about audits by state examiners:
In addition to state politics, other serious limitations of State Examiners exist.
First, State Examiners generally lack experience and expertise in the specialized
needs of the public pension fund organization. Principally, their auditing expertise
lies in the expense and departmental operational accounts that revert to the state,
and not organizations that carry over hundreds of millions of dollars each year.
Second, State Examiners are seriously limited in manpower and budget, thus
allowing only 2 or 3 auditors on a particular audit. It should be quite obvious that
a complete audit demands experts in such fields as administration, investments,
data processing, actuarial sciences, records management, as well as the traditional
accounting techniques and methodologies.
Financial institutions, such as banks and insurance companies are audited by as
many as 4 or 5 different private and/or public agencies, and they are continuously
finding shortcomings in management and performance. In my opinion, there can-
not be enough audits when it comes to keeping a close eye on hundreds of millions
of dollars being invested for the vital needs of hundreds of thousands of citizens
of your respective states.23
The lack of an independent review of public pension plan financial
and actuarial matters carries an attendant risk of financial mis-
calculation or abuse. In regard to the need for independent review,
public pension plans cannot be viewed differently from other financial
enterprises including the sponsoring governmental employers them-
selves. While related to the area of municipal finance generally, the
following statement in regard to New York City's recent financial
problems made at a news conference by Comptroller Harrison J.
Gold in could have equal significance in the public pension plan
context:
3' Article by Dr. David G. Bronncr, Retirement Systems of Alabama Advisor, Vol. Ill, No. 12, July 1977i
71
Most important of all, what have we learned from the ordeal of this period?
1. We have learned the risk when there is no outside, independent review and
oversight of the city's condition, the kind of independent review that began with
the audits I released in the summer of 1974. We must be sure that such review and
oversight continue to exist.
2. We have learned that the shambles and chaos of the city's accounting
system, which I revealed, made it impossible to maintain effective control or to
secure reliable data. Uniform accounting standards must be required for all
municipalities as a matter of law.24
A recent Coopers & Lybrancl — University of Michigan report on
Financial Disclosure of the American Cities concluded that compliance
with voluntary standards relating to accounting, auditing, and fi-
nancial reporting practices is ineffective :
Our findings indicate a substantial lack of compliance with current generally
accepted principles applicable to governmental bodies. These findings support
our recommendation that disclosure compliance for the protection of taxpayers
and security investors should be accomplished through uniform enforcement.
The MFOA [Municipal Finance Officers Association] recommends compliance
with GAAFR [Governmental Accounting, Auditing and Financial Reporting].
However, the organization issues fewer than 40 Certificates of Conformance each
year. In fact, only about 400 such certificates have been issued over the last 30
years. Out of approximately 18,000 municipalites eligible to apply, only about
100 applications are even submitted annually for consideration. This points up
the hopelessness of voluntary compliance.25
PLAN DISCLOSURE TO PARTICIPANTS
The persons administering public employee retirement S3^stems are
rarefy obligated to cany out their fiduciary duties "solely in the
interests of plan participants and beneficiaries." The loyalties of plan
administrators at the federal, state, and local levels are divided, at
various times and to various degrees, between authorizing or appro-
priating legislative bodies, elected or appointed executive officials,
various boards, and the special interests of board members including
in most cases elected or appointed representatives of plan participants.
Plan administrators may also be confronted with conflicting and con-
fusing statutes and court interpretations creating legal uncertainties
as to plan provisions and operations. The above factors as well as
others have contributed to a wide-range of public pension plan dis-
closure practices.
In many cases plan disclosure to participants is inadequate or non-
existent. In such cases plan participants and beneficiaries (and other
interested parties as well) are unable to assess properly plan financial
operations, are unappreciative of the true level of pension costs, and
are unaware of conditions leading to benefit losses. There is an increas-
ing recognition on the part of public pension officials of the need for
additional disclosure of public pension plan financial and funding
operations.26 Later chapters deal with present plan practices in these
particular areas.
In various ways some of the largest public employee retirement
systems give recognition to the importance of meaningful disclosure
in furthering participant understanding of oftentimes complex benefit
24 New York Times, August 29, 1977, p. 20.
85 Financial Disclosure Practices of the American Cities, Coopers and Lybrand and the University of Mich-
igan, Washington, D.C., 1976, p. 37.
26 For example, see the recommendations of Mr. Robert E. Blixt, of the Minnesota State Board of In-
vestment, in Pension World, Vol. 12, No. 12, December 1970, p. 3-4.
72
provisions. The plan description of one large system instructs plan
participants in the following manner: "You are urged to acquaint
yourself with the information contained herein and to review it from
time to time so that you will be familiar with the obligations and
rights, and can plan intelligently for the future."
Survey data suggests that participants in a majority of all public
pension plans are hindered in their ability to "plan intelligently for the
future" due to inadequate disclosure of plan provisions. Public pension
plan disclosure practices may be tested against any of several basic
principles of effective communication: (1) that plan materials be
readily available; (2) that the materials be timely and up-to-date; (3)
that the materials be comprehensive so as not to omit important plan
features; and (4) that information be presented in a manner that will
be understood by plan participants and beneficiaries.
While nearly 85 percent of all state-run plans automatically provide
plan participants with booklets or other materials describing plan
provisions, only 42.2 percent of locally administered plans so provide
(see Table C4). The high percentage of teacher plans, 92.7 percent,
automatically furnishing plan descriptions is noteAvorthy. While all or
nearly all university and college faculty and others participating in
plans funded through Teachers Insurance and Annuity Association of
America— College Retirement Equities Fund (TIAA-CREF) auto-
matically receive plan descriptions, about 61 percent of the large
teacher plans administered at the state level automatically distribute
plan descriptions to all participants. In contrast, plan participants in
over one-fifth of all other plans are unable to obtain plan descriptions
even upon request.
73
74
Where plan descriptions are furnished automatically or upon request,
there exists great variation in the form and usefulness of such mate-
rials. Some of the largest plans distribute elaborate and comprehensive
plan "booklets". In other cases descriptive "pamphlets" are so brief
as to be of little help to participants seeking answers to practical
questions. Some plans, upon request, will furnish verbatim copies of
the applicable sections of state and local law which may be incom-
prehensible to all but the most sophisticated plan participants.
To be useful and to avoid misleading plan participants, plan de-
scription materials should be kept up-to-date with plan amendments
and other changes. For the most part the public pension plans furn-
ishing participants with plan descriptions on an automatic basis
indicate that such materials are periodically updated or rewritten.
For some plans, however, substantial periods of time may elapse
between plan description updatings.
The following example illustrates the potential which is created
for benefit losses when plan disclosure falls short of some of the "basic
principles" of participant communication given above. The case in
point, involving the employees of several federal employing offices,
also serves to illustrate the unique problems which multiple employer
plans have in dealing with, in some cases, thousands of separate
employers. The plan description for the participant group in question
was issued nearly eight years ago and is currently out-of-date in
several respects. The document is not distributed automatically, is
nearly out-of-print, and the availability of the document is unknown
to many, if not most, of the employees involved.
Under plans exhibiting circumstances similar to the above, plan
participants may be generally unaware of important retirement fea-
tures and valuable coverage in the event of death or disability. Par-
ticipants and beneficiaries may also be unappreciative of the voluntary
or mandatory aspects of various portions of their benefit plans, thus
forfeiting benefits otherwise attainable under "portability" and "buy-
back" provisions (see Chapter D). various survivor and retirement
options, or optional benefit programs. An inadvertent loss of benefits
can also occur when participants and beneficiaries are not made
familiar with plan vesting provisions or with remarriage, reemploy-
ment, or earnings limitations that apply after benefits commence.
The contributory nature of most public employee retirement
systems creates special needs for plan disclosure and employee under-
standing if benefit losses are to be avoided. In such plans, many
employee benefit rights hinge on the disposition of emplo^^ee
contributions.
A glaring weakness of contributory retirement systems presently
is the inadequate means of informing participants of their rights to
vested benefits or to the return of their own contributions upon ter-
mination. About one-half of all federal, state, and local plans do
not automatically furnish employees with statements of their contri-
butions (See table C4). In over 8 percent of the plans, the partici-
pants are unable to receive such statements even upon request. In
contrast, nearly all teacher plans (including TIAA-CREF plans)
supply their members with individual statements of employee
contributions.
75
The results are predictable. Many pension plan membership rolls
and trust funds are clogged with the names and accumulated con-
tributions of former members with which the plans have lost total
contact. The problem is a multi-million doilar one. and the only way
some governmental jurisdictions have acknowledged the problem is
by trying periodically to expropriate the unclaimed pension funds
under state escheat laws.27 The problem of unclaimed benefits has
also been a perennial one for the federal Civil Service Retirement
System. A 1972 General Accounting Office report estimated 338,000
former federal employees aged 62 or over as having potentially
unclaimed benefits totaling $26 million.28
The federal government attempted to deal with this problem by
passing Public Law 94-183 which established a time limitation in
applying for civil service retirement benefits. Under present law, no
benefit will be paid unless former employees apply for benefits before
their 115th birthday, and after the death of an employee unless the
application is received within 30 years after death. The effect of these
provisions is to authorize the Civil Service Commission to destroy
retirement records when no claim for benefit has been received within
the periods specified by law. While this may solve the recordkeeping
problems, it does not solve the problem for the individuals who may
need this income in their retirement years. The GAG concluded that
"returning the money would serve a purpose as useful as, or more
useful than, correcting a serious recordkeeping problem and would
provide benefits expected of the Government." Accordingly, GAO
recommended that a program be implemented to return unclaimed
retirement funds and that federal agencies be advised of the extent
of unclaimed benefits and reemphasize the importance of providing
proper counseling to people leaving Government employment so they
will be aware of their rights to retirement benefits.
Many employers furnishing individual statements of employee
contributions do so as part of their payroll operations. In such cases
employees may be unaware of the importance of retaining payroll
"stubs" for retirement benefit purposes. In the absence of effective
disclosure of plan provisions, employees who quit may forfeit vested
employee contributions or other benefits regardless of whether or not
individual contribution statements are furnished them while working.
The result is that federal, state, and local pension plans have accumu-
lated millions of dollars in unclaimed benefits for, perhaps, hundreds
of thousands of former employees.29 The fact that the federal system
retains the contributions of approximately two million former federal
employees suggests that the problem of unclaimed benefits will con-
tinue for this system as well.
To avoid such losses and to better inform participants of their
rights, some plans provide emplo}Tees with benefit statements con-
taining information on accrued benefits or accumulated contributions.
27 New Jersey's Contributory Public Employee Pension Programs: Program Analysis of the Public Em-
ployee?' Retirement System, Office of Fiscal Affairs of the New Jersey State Legislature, March 11)76. p. viii.
M Report to the Congress by the Comptroller General of the United States, Unclaimed Benefits in the Civil
Service Retirement Fund. December 20. 1972.
29 See New Jersey's Contributory Public Employee Pension Programs: Program Analysis of the Public
Employees'. Retirement System, Office of Fiscal Affairs of the New Jersey State Legislature, March 1976.
p. v-vi; also see Report to the Congress by the Comptroller General of the United States, Unclaimed Benefits
in the Civil Service Retirement Fund, December 20, 1972.
74-36D— 7S 6
76
About one fourth of all plans, including about 60 percent of the state
plans and 20 percent of the local plans, automatically furnish parti-
cipants with such information (see table C4). Participants in 19 percent
of all plans cannot obtain such information even upon request. When
participants are not provided information as to the value of their
accrued benefits at tne time of termination, losses other than those
resulting from unclaimed benefits may occur. Participants may with-
draw their own contributions, and in some cases may even be pro-
cedurally encouraged to do so, thus forfeiting deferred retirement
benefits having a much greater value than the lump sum return of
contributions.
There is a wide variation in the degree of administrative attention
given to supplying information to terminated participants and keeping
records related to such individuals. Many plans were unable to
separately identify terminated participants from active participants.
For large plans providing such information, the number of former
employees with deferred vested benefits ranged from less than 5
percent of the number of persons currently receiving benefits to over
100 percent.
Public pension plans of the multiple employer type exhibited
special problems in supplying information on the number of ter-
minated participants. To the benefit of employees such plans count
service with all contributing employers for purposes of computing any
one employee's final pension. Most multiple employee plans also
accumulate service without regard to the length of any "break-in-
service" (see Chapter D and Table 24 of Appendix I). Because the
presence of such provisions makes it difficult to identify "terminated"
participants, disclosure of accrued benefits to such persons is often-
times nonexistent.
At any one time multiple employer plans are also likely to have less
than complete information on the benefit status of a given participant.
This is usually due to the retention of employee records at the con-
tributing employer level with the consolidation of such records
occuring only at termination, retirement, or other more regular
intervals (one result is that some plans are unable to report the total
amount of accumulated contributions for a given participant or for
the plan as a whole.) Under these plans greater reliance is also placed
on the ability of employees to remember or, perhaps, provide proof
of applicable periods of past employment for benefit purposes. The
chance for errors to occur thus leading to inaccurate benefit compu-
tations is further enhanced if participants fail to understand the
"system" and the need in some cases to keep records of past
service and contributions. The recordkeeping problems are com-
pounded when a retirement system fails to utilize a unique identifier
(such as the Social Security number) for each participant. In such
circumstances benefit losses have an even greater chance of occuring
in the event of the death or mental impairment of the participant.
In summary, the disclosure practices of public employee retirement
systems at the federal, state, and local levels fall considerably short of
the high standards set for private pension plans under ERISA. While
some larger plans may provide participants with ERISA-like plan
descriptions and financial statements, only a small percentage of all
77
public pension plans could presently meet all of the ERISA dis-
closure provisions requiring: (1) summary plan descriptions written
in a manner calculated to be understood by the average plan par-
ticipant, (2) summary descriptions of material plan modifications,
(3) summary annual reports of plan finances, (4) statements of
accrued and vested benefits upon request and at termination,
(5) written explanations of claims denials, and (6) access to all plan
documents including financial and actuarial reports.
Internal Revenue Code Qualification
The question as to whether or not public employee retirement
systems need to obtain plan "qualification" under section 401(a)
of the Internal Revenue Code has been subject to misunderstanding
and confusion. Public pension plan administrators and other officials
have admitted^ been reluctant to voluntarily submit their plans
to the Internal Revenue Service for review.30 The minimal enforcement
and unequal application of section 401(a) by the Internal Revenue
Service as it relates to public plans has also contributed to the general
state of confusion.31
The uncertainties of public pension plans as to any obligations
they may have under the Internal Revenue Code are highlighted
in Table C5. Well over three-quarters of all plans have failed to seek
IRS qualification, and about 57 percent of those queried professed
to be unfamiliar with the application of the Internal Revenue Code
to their plans. About 44 percent of the federal plans, 23 percent of
the state plans, and 14 percent of the local plans applied for and
received favorable plan determination letters in the past. Over 60
percent of the determinations, however, occurred five or more years
ago. This indicates that even those plans seeking initial qualification
usually do not seek later rulings when their plans are amended.
TABLE C5— APPLICATION OF INTERNAL REVENUE CODE QUALIFICATION PROCEDURES UNDER SEC. 401(a) TO
RETIREMENT SYSTEMS
[In percent of plans]
Received favorable
IRS determina-
tion letter— Received
unfavor- Applied
Not
Did not
In last
able IRS
but no
familiar
apply for
5 yrs
Prior
deter-
deter-
with
qualified
(1971-
to
mination
mination
System category
process
status
76)
1971
letter
letter
Unknown
Total
1. Federal Government.-
14.5
30.9
32.7
10.9
5.4
5.4
100
State and local government:
II. By level of administration:
A. State administration...
18.9
55.6
4.4
18.5
1.0
1.5
100
B. Local administration...
68.0
16.5
6.0
8.2
1.3
100
Total
57.5
19.0
5.3
8.6
.1
1.2
8.0
100
Note: Data relates to Table 13 in app. 1.
30 Commonwealth of Pennsylvania Public School Employees' Retirement System Audit Report for yeart
ended Ju ne SO, 1973 and 1974, P- 24.
31 Alvin D. Lurie, Assistant IRS Commissioner (Employee Plans/Exempt Organizations), address before
the National Symposium on Public Employee Retirement Systems, Washington, D.C., September 14,
1977, p. 2.
78
The reasons given by some plans as to why IRS determination was
not sought are illuminating:
(1) Does not apply to municipal governments.
(2) Technically not a qualified plan, but IRS treats as qualified plan
for tax purposes.32
(3) The University is exempt from income tax so there is no tax
advantage.
(4) Told verbally by IRS representative that system is automatically
qualified.
(5) Attorney has advised that the system would not be eligible and
therefore need not apply.
(6) The benefits of qualified status would not justify the potential
problems generated by conflicts between IRS rulings and state
statutes.
(7) Have not had either the legal or administrative staff to fight the
long war with IRS to obtain qualification. IRS will not give pre-
liminary advice on proposals, consequently greatly complicating and
raising the cost of obtaining qualification.
About 4 percent of the state plans seeking qualification failed to meet
the IRC section 401(a) requirements. Federal and local plans seeking
qualification indicated no problems in obtaining approval. Although
inconclusive, the small percentage of state plan applications rejected
by the IRS may indicate problems which some state plans have had in
meeting the nondiscrimination requirements of IRC Section 401(a)
(e.g. where highly compensated elected or other officials receive bene-
fits of proportionately greater value than other state employees;.33
The state of confusion over the application of IRC section 401(a)
to public pension plans has been resolved at least for the time being.
As given in Appendix X, the Internal Revenue Service position clearly
states that Internal Revenue Code Section 401(a) does apply to public
employee retirement systems. For plans failing to meet the provisions
of the Code, the tax consequences to the plan's participants and bene-
ficaries as well as to the related trust may be severe. One source
estimates potential tax liabilities exceeding $388 million may be
incurred by public pension trusts, if they fail to meet the section 401 (a)
qualification standards.34 Addressed in part II of this report — federal
laws presently affecting PERS —are the various legal aspects relating
to the qualification of public pension plans.
As the surveys shows, the participants and beneficiaries of most
public employee retirement systems do not benefit from the safe-
guards of the nondiscrimination, the prohibited transaction, and the
other plan qualification provisions of the Internal Revenue Code.
The applicability of such provisions in the public pension plan context
must be carefully reassessed, however, in order to ensure that future
applications of the same or similar standards do not directly or
inadvertently hinder the funding progress of some plans. For example,
one state administrator claims that as a result of an IRS recommenda-
tion to eliminate plan discrimination, the state set up a separate
21 See Appendix XT for a clarifi cation of the tax qualification status of the Civil Service Retirement
Sy stem and other Federal systems.
" Pensions & Investmtnts, June 21, 1976, "Inconsistency of IRS Qualification Policy for Public Funds
is Shown," p. 24.
34 Library of Congress, Congressional Research Service, estimated liabilities calculated as of June 30, 1976.
79
unfunded plan for judges, legislators, and elected officials who were
previously covered under a funded plan for other state employees.35
However, at the present time there is little additional evidence to
indicate that any of the public pension plans that now operate on an
unfunded basis (17 percent) do so as a result of a deliberate decision to
avoid the application of section 401(a) of the Internal Revenue Code.
RECORDKEEPING AND OTHER PROCEDURES
Early public emplo}ree disability and pension programs started out
as extensions of city payroll operations. In a few large cities and
numerous small ones, pension operations have not progressed much
beyond this early stage. Most large city and state systems, however,
have made substantial progress, many in the last decade or so, in
bringing modern management and computer techniques to bear on
their pension operations.
Nonetheless, large public employee retirement systems of the
multiple emplo}rer variety experience some unique administrative
problems of their own. Obtaining and maintaining recorded data relat-
ing to, in some cases, thousands of participating employers and several
hundred thousand employees present major problems for multiple
employer plans. Recordkeeping problems are encountered by such
plans even when elaborate rules, regulations, and procedures are
spelled out and made applicable to all participating employers. The
lack of adequate staff follow-through or auditing, which may in turn
result from a shortage of administrative funds, can result in the loss of
plan income or employee benefits. Some plans experience delinquencies
in the payment of contributions, and at least one plan has had to deal
with the possibility of employer default.36 Problems in obtaining accu-
rate and complete employee payroll and other data serve to undermine
the reliability of . actuarial valuations and of computed contribution
rates.37
Multiple employer plans often lack up-to-date information on the
membership and employment status of individual employees. Some
plans, such as the Federal Civil Service Retirement System, rely on
participating employers to maintain employer service and contribu-
tion records and may never combine all individual records until
benefits are claimed. As a result, such plans may not know the number
of terminated vested employees and may have trouble estimating the
related effect on benefit costs.
SUMMARY AND CONCLUSIONS
1 . PEES development and consolidation
The development of the public employee retirement S3rstem began
earlier than the private pension system. Over 12 percent of the largest
state and local plans in current operation were established before 1930.
35 Pensions & Investments, June 21, 1976, "Inconsistency of IRS Qualification Policy for Public Funds
is Shown," p. 24.
3« Hearing before the Subcommittee on Labor Standards of the Committee on Education and Labor,
94th Congress, 1st Session, on H.R. 9155, Washington, D.C., September 17, 1975. p. 316-317.
37 For example, see the Comm onwealth of Pennsylvania State Employees Retirement System Auditor General
Report of Examination for the period June, 1973 to December 31, 1974: in another case an actuary resigned after
being unable to obtain reliable employee data, see New Orleans Times-Picayune, January 8, 1974.
80
The number of large public plans increased dramatically during the
period just prior to the enactment of Social Security legislation in 1935
but before optional coverage was afforded state and local government
employees. Over 40 percent of the larger state and local plans have
increased their scope of operations by adding new employee groups to>
their coverage. Many new plans have consolidated operations in an
attempt to rationalize benefit policy and to gain expertise and effi-
ciencies in plan management, accounting, actuarial, computer, and
investment functions. Plan consolidation has resulted in administrative
savings and proved beneficial in some cases; but there can be barriers
as well as some disadvantages to consolidation.
2. Public pension policy
With notable exception, most governmental jurisdictions, at all
levels, have not developed an overall policy framework to serve as a
guide for dealing with public pension issues. Historically, the PERS
has taken shape through the addition of a patchwork of laws and pro-
grams, creating complexity and confusion. A unique aspect of the
public sector in dealing with pension matters is the reluctance or
inabilit}^ of one legislature or administration to commit its successors
to a particular policy or course of action. The absence of a discernible
pension policy may result in the lack of meaningful financial bene-
fit disclosure ; the lack of auditing and actuarial standards and reports ;
inequitable benefit structures; rapidly escalating pension costs result-
ing from inadequate levels of funding; and complexity and confusion
caused by divided pension responsibilities among different juris-
dictions and between different agencies or branches of the same
jurisdiction.
Some states have formed retirement commissions to enable legisla-
tures and administrations to deal with pension matters more effectively
on a long-range basis. States with retirement commissions are more
likely to have catalogued information on the plans operating within
their jurisdictions than other states, many of which were found
to have little knowledge of the number and types of plans operating
within their boundaries.
3. Retirement system administration
While the survey data show that larger plans are generally better
managed than smaller plans, in some cases larger plans display the
same administrative weaknesses as smaller plans.
With rare exception, the administrative responsibility for large
public plans is vested in a retirement board, whereas plan administra-
tion in nearly one-third of all smaller state and local pension plans is
carried out under the offices of elected public officials. The effective-
ness and sensitivity with which a retirement board can deal with
complex administrative and investment issues is dependent on the
interest, experience, and abilities of its individual members. As
diligent as some administrators have been in fulfilling their duties, the
lack of clear-cut pension policies, direction, and control has prevented
some systems from overcoming certain administrative weaknesses-
This has been most apparent in the administration of the disability
programs of some systems — large and small. Administrative laxity in
the disability area has forced at least one plan in the past into court
appointed receivership. In other benefit areas, administrative proce-
81
dures have proved inadequate to prevent certain benefit provisions
from resulting in favoritism, other inequities, and abuse.
4. Retirement system audits
In general, public pension plans at all levels of government do not
appear to be operated within the generally accepted financial and
accounting procedures applicable to private pension plans. The most
striking characteristic of public employee retirement system
audits is the absence of any uniform or standard auditing practice.
A substantial segment of the public employee retirement system is
characterized by the absence of any regular or external independent
review of plan operations. Nearly one-third of all state and local plans
and 37 percent of the larger ones do not provide for annual audits.
Some of the largest public pension plans in the country are only
audited every four or five years, and they are audited at that time by
related governmental agencies rather than an external independent
auditor. About 4.6 percent of all state and local plans and 29.1 percent
of all federal plans are not audited at all. The lack of a regular, inde-
pendent review of public pension plan financial and actuarial matters
carries an attendant risk of financial miscalculation or abuse.
5. Plan disclosure to 'participants
In summary, the disclosure practices of public employee retirement
systems at the federal, state, and local levels fall considerably short
of the high standards set for private pension plans under ERISA.
A wide range of public pension plan disclosure practices exists in the
PERS. In many cases plan disclosure to participants is inadequate or
nonexistent. In such cases plan participants and beneficiaries (and
other interested parties as well) are unable to assess properly plan
financial operations, are unappreciative of the true level of pension
costs, and are unaware of conditions leading to benefit losses.
Over one-fifth of all state and local pension plans do not prepare or
supply plan participants with plan descriptions. Less than a majority
of the state and local plans and 69 percent of the federal plans make a
regular practice of updating and distributing plan descriptions of one
form or another.
Where plan descriptions are furnished automatically or upon
request, there exists great variation in the form and usefulness of such
materials. Some of the largest plans distribute elaborate and com-
prehensive plan "booklets". In other cases descriptive "pamphlets''
are so brief as to be of little help to participants seeking answers to
practical questions.
A glaring weakness of contributory retirement systems is the
inadequate means of informing participants of their rights to vested
benefits or to the return of their own contributions upon termination.
About one-half of all federal, State, and local plans do not automati-
cally furnish einp^ees with statements of their contributions. In
over 8 percent of the plans, the participants are unable to receive
such statements even upon request.
The results are predictable. Many pension plan membership rolls
and trust funds are clogged with the names and accumulated contri-
butions of former members with which the plans have lost total
contact. The problem is a multimillion dollar one, and the only way
some governmental jurisdictions have acknowledged the problem is by
82
trying periodically to expropriate the unclaimed pension funds under
state escheat laws. The problem of unclaimed benefits has been a
perennial one for the Federal Civil Service Retirement System. A 1972
General Accounting Office report estimated 338,000 former federal
emplo3^ees aged 62 or over as having potentially unclaimed benefits
totaling $26 million. The fact that the federal S3^stem retains the
contributions of approximately two million former federal employees
suggests that the problem of unclaimed benefits will continue for this
s}^stem as well.
6. Internal Revenue Code qualification
Generally, public pension plan officials have been unmindful of the
tax obligations extending to employees and their pension funds in the
event certain qualification requirements of the Internal Revenue Code
(e.g. IRC section 401(a)) are not met. The uneven enforcement by
the Internal Revenue Service of Code provisions applicable to public
pension plans has undoubtedly contributed to the confusion of public
officials as to their obligations in this area. Nearly 58 percent of the
state and local and 15 percent of the federal plan administrators pro-
fessed to be unfamiliar with the application of Internal Revenue Code
qualification procedures. Onhr about 15 percent of the state and local
and 50 percent of the federal plans have applied to the IRS for a
determination of their qualified status. Because public plans have not
been uniformly subjected to the qualification provisions of the Inter-
nal Revenue Code in the past, many public plans lack the safeguards
inherent in private plans even prior to ERISA.
7. Recordkeeping and other procedures
Early public employee disability and pension programs started out
as extensions of city payroll operations. In a few large cities and
numerous small ones pension operations have not progressed much
beyond this early stage. Most large city and state systems, however,
have made substantial progress, many in the last decade or so, in
bringing modern management and computer techniques to bear on
their pension operations. Nonetheless, large public employee retire-
ment systems of the multiple employer variety experience some unique
administrative and recordkeeping problems of their own. Obtaining
and maintaining recorded data relating to, in some cases, thousands
of participating employers and several hundred thousand employees
present unique problems for multiple employer plans. Multiple em-
ployer plans often lack up-to-date information on the membership and
employment status of individual emplo}rees. As a result such plans
may not know the number of terminated vested employees and may
have trouble estimating the related effect on benefit costs.
Chapter D — PERS Participation, Vesting, Portability, ani>
Plan Termination Provisions
The Employee Retirement Income Security Act of 1974 (ERISA)
extends important pension plan protections to employees in the pri-
vate sector. These protections include minimum standards relating
to pension plan participation and vesting (ERISA Title I, Part 2).
The law also provides for termination insurance (ERISA Title IV)
which guarantees the payment of vested pension benefits, subject to
certain limitations, when a plan terminates with insufficient assets.
Certain provisions under ERISA also permit a modicum of pension
portability. This chapter discusses the extent to which public em-
ployees enjoy similar protections under federal, state, and local govern-
ment pension plans.
PARTICIPATION (MEMBERSHIP) REQUIREMENTS
Generally, ERISA requires private pension plans to begin accruing
benefits for employees who are age 25 or older after they have com-
pleted one year of service (employment). A provision requiring em-
ployees to be age 25 and to complete three years of service may be
substituted, if the plan has immediate vesting. Also, any plan main-
tained for employees of an educational organization which is tax-
exempt under Internal Revenue Code section 501(a) may use an age
30 and one year of service eligibility requirement, if it provides im-
mediate vesting. Employees meeting the minimum age and service
requirements must be permitted to commence participation at the
beginning of the next plan year, thus extending the service period
beyond one year or three years, but not more than six months beyond
such period.
It can be seen (Table Dl) that most public employees are in plans
with more liberal participation provisions than those required by
ERISA. Nearly 60 percent of the total number of state and local
government plans covering 97 percent of all active participants have
no minimum age requirement. Approximately the same number of
plans, covering nearly 84 percent of all active employees, have no
minimum service requirement. The two largest federal plans, the Civil
Service Retirement System and the Military Retirement System, both
permit immediate participation (i.e. no minimum age or service is
required). The most notable exception to the typical "no minimum
age" provision is the 21 years of age requirement found in 50 percent
of the police and fire plans covering 30 percent of the employees in
that category.
Approximately 2 percent of the public employees are in pension
plans having age and service requirements which do not meet ERISA
minimum standards. The plans requiring higher ages or greater
lengths of service for participation than ERISA amount to between
(83)
84
14.2 percent and 17.6 percent of the total number of state and local
government plans. Such plans typically have less than 1,000 active
participants.
Another ERISA age-related eligibility condition restricts the max-
imum age limitations which are commonly found in private pension
plans. This ERISA rule prohibits a private pension plan from ex-
cluding employees solely because they have attained a particular age.
An exception to this rule permits defined benefit and target benefit
plans to exclude employees who are hired within 5 years of a plan's
normal retirement age (usually age 65).
It can be seen (Table Dl) that only 7.7 percent of the state and
local government employees are covered by plans having a maximum
age limitation of less than age 60 (which might result in more restricted
participation at the older ages than would be permitted under the
ERISA rule). For such plans covering general government employees
the maximum age limitation is typically age 55. Since the normal re-
tirement age for many of these plans is also age 55, the maximum age
limitation is probably not more restrictive than that permitted under
the ERISA rule. However, this is not the case for many police and
lire plans. Over 35 percent of the police and fire plans covering nearly
25 percent of the total employees in that category have a maximum
age limitation of age 35 or less. This age usually corresponds to the
maximum age established by police and fire departments for hiring
purposes.
The two largest federal plans covering civilian and military per-
sonnel do not have a maximum age limitation. However one-third
of the federal plans do have a maximum age limitation of between
age 60 and 64. Four federal government plans have maximum age
limitations, between ages 56 and 58, which would not meet the ERISA
standards. Three of these four plans cover the nonappropriated fund
employees of the U.S. Coast Guard, Navy, and Marine Post Ex-
changes. The other plan is maintained by the Columbia, South
Carolina Farm Credit District.
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86
EKISA generally requires that pension benefits be made available
at normal retirement age to persons retiring with five years of service.
An exception to this rule is allowed under ERISA when normal
retirement age is defined as the later of age 65 or the 10th anniversary
of the time the employee commences participation in the plan. While
public employee plans are generally free of restrictive maximum age
limitations, with the exception of the police and fire plans noted above,
many plans do require more than five years of service (or participa-
tion) before benefits become payable regardless of whether participa-
tion commences before or after normal retirement age. The service
requirement is usually the same as that required for vesting (which is
taken up in the next section).
The one aspect of participation in which public pension plans fall
considerably short of the ERISA minimum standards involves the
coverage of part-time employees. ERISA requires that a "year of
service" for participation purposes be credited an employee who works
at least 1,000 hours during a 12-month period. It can be seen (Table
Dl) that three-quarters of the state and local plans, covering 37.4
percent of the total membership, do not extend plan participation to
employees working 1,000 hours per year. Undoubtedly many of the
part-time employees working at least 1,000 hours per year are also
excluded from the 16.4 percent of the plans (Table Dl), covering
36.4 percent of the total membership, for which the minimum hours for
eligibility are unknown.
Using full-time only coverage as an indicator, plans covering teach-
ers (other than higher education) appear to be the least restrictive
in their coverage of part-time workers while police and fire plans are
the most restrictive. For plans including part-time employees, 1,040
hours per year is one typical coverage requirement, thus indicating
that public employee retirement systems have also given recognition
to the ERISA principle that employees who work at least "half-time"
should be covered.
Because many plans require a restrictive number of hours service
for participation, part-time public employees make up the largest
segment of the public sector workforce who remain without pension
coverage. As a result, probably more than 50 percent of the public
employees working less than full-time lack pension coverage (see
also Chapter B).
The coverage of part-time empWees is a factor which also relates
to the "breadth of coverage" requirements of section 401(a)(3) of the
Internal Revenue Code (as in effect before ERISA) which continue
to apply to governmental pension plans seeking to maintain their
qualified status on a current basis (see Part II-Internal Revenue
Code for a discussion of how the IRC applies to governmental plans).
Generally section 401(a) (3) requires that for a governmental plan to
qualify 70 percent or more of all employees, exclusive of short service
(five years or less), seasonal (5 months per year or less), and part-
time employees (20 hours per week or less), must be covered or at
least 70 percent of the employees (similarly defined) must be eligible
for coverage under the plan and 80 percent of such eligibile employees
must actively participate.
It appears that few, if any, large public employee retirement systems
would have problems meeting this standard, even though participation
87
may be limited to full-time employees. However, small public pension
plans — particularly those maintained at the township level where 45%
of the employees work part-time — may have to include some part-
time employees, if the Internal Revenue Code qualification require-
ments are to be satisfied.
VESTING AND RELATED REQUIREMENTS
Generally, ERISA requires that the portion of an employee's
accrued benefit derived from his own contributions be nonforfeitable
(i.e. 100 percent vested). The portion of the employee's accrued benefit
derived from employer contributions must be vested in accordance
with one of three minimum vesting rules :
1. Ten-year service rule .-100 percent vesting after 10 years of service;
2. Graded 15-year service rule. — 25 percent vesting after 5 years
of service; then 5 percent additional vesting for each year of service
from year 6 through 10, then 10 percent additional vesting for each
year of service from year 11 through year 15, so that the employee is
100 percent vested after 1 5 years of service ; and
3. Rule of 45. — 50 percent vesting after 5 years service or, if later,
when age plus service equals 45, such percentage increasing by 10
percent each year until 100 percent is reached; additionally a parti-
cipant under the Rule of 45 must be 50 percent vested after 10 years
of covered service, such percentage increasing by 10 percent for each
additional year of covered service, so that the employee is 50 percent
vested after 10 years and 100 percent vested after 15 years regardless
of age.
' The vesting provisions in the retirement plans for public employees
are compared with ERISA minimum standards in Table D2. Nearly
71 percent of the total plans covering slightly over 20 percent of the
'total number of state and local government employees have either no
vesting or later vesting than that required by ERISA.
Only 2.4 percent of the state and local government employees are in
plans with no vesting. Nearly all of the employees without vesting are
local policemen and firefighters (26 percent of all such employees) who
are usually required to work 20 or 25 years to obtain a pension. The
2.2 million members of the federal uniformed services remain the
largest group of employees, inside or outside government employ-
ment, with no pre-retirement vesting of pension benefits.
At the other end of the vesting spectrum, over 38 percent of the
total number of state and local government employees are covered by
pension plans with vesting after 5 years or less. Less than 4 percent of
such employees have immediate vesting, although 36 percent of the
teaching staff of public colleges and universities obtain immediate
vesting under their defined contribution plans funded through the
Teachers Insurance and Annuity Association and its affiliate, the
College Retirement Equities Fund. Several small federal plans are
also funded through TIAA-CREF and have immediate vesting (see
Table VI of Appendix IV). With minor exception the remaining fed-
eral civilian emplo}"ees obtain vesting after five years of service.
As is the case in private pension plans, the most typical public
pension plan vesting provision is 100 percent after 10 years of service.
Nearly 30 percent of the plans covering over 40 percent of the state
88
and local government employees provide straight ten years of service
vesting. Slightly less than 9 percent of the state and local plans,
covering about 5 percent of the total employees, require a minimum
age and service time for vesting. Nearly all such plans fail to meet
ERISA's "Rule of 45" vesting provision. Only 8 percent of the total
number of state and local government employees are covered by plans
(comprising about 20 percent of the total number of plans) utilizing a
graded vesting schedule. It is believed that the graded vesting in most
plans would meet the "Graded 15- Year Service Rule" under ERISA,
TABLE D2. — RETIREMENT SYSTEM VESTING PROVISIONS
|ln percent]
Plans with service vesting
Plans
with no
vesting
only
Plans
with age
and service
vesting
Total
plans
with
vesting
Employee category
5 yrs
or less
6 to
10 yrs
Over
10 yrs
Total
EMPLOYEES
Federal
43.3
54.7
1.0
.3
.7
56.7
100
Stats and local total:
State
39.7
47.7
10.6
1.9
100.0
100
Local
Police and fire
Teacher
1.1
26.0
34.3
16.9
41.4
43.5
22.9
37.8
18.3
23.5
12.3
2.6
10.7
8.4
98.9
74.0
100.0
100
100
100
Teachers (higher education)
66.3
26.6
4.4
2.2
100.0
100
Total
2.4
38.3
41.2
13.1
4.9
97.6
100
PLANS
Federal
25.6
41.9
14.0
4.7
14.0
74.4
100
State and local total:
State and local government
Police and fire
Teachers (including higher education)
13.5
72.9
24.1
3.2
91.0
34.7
8.0
5.8
12.8
8.5
1.8
14.8
7.3
1.5
86.5
27.1
100.0
100
100
100
Total
52.8
15.0
14.5
9.0
8.7
47.2
100
Note: Data relates to tables 21 and 22 in app. I.
The effect of the vesting provisions shown in Table D2 is that 38
percent of the total number of state and local government employees
currently have attained a vested right in their accrued pension bene-
fits (employer financed portion).1 The percentage of active employees
with vested rights in locale-administered plans, 32 percent, is less
than the percentage of vested employees in state-administered plans,
39 percent, reflecting the more restricted vesting found among local
plans (especially those covering policemen and firefighters). The
much larger percentage of vested employees in the Federal Civil
Service Retirement S3'stem, over 60 percent, is reflective of the five
year vesting provisions in that plan.
A substantial percentage of the remaining empWees in public
plans with vesting, but who are not currently vested, will ultimately
achieve vested status. For example, the experience of one large public
employee retirement system with ten year vesting shows that a newly
hired employee has the following chance of attaining vested status —
22 percent if hired at age 25, 48 percent if hired at age 35, and 56
1 See table 23 in appendix I for more detail on the percentage of active public employees
•who are currently vested.
89
percent if hired at age 45.2 The employees in plans requiring more
than ten years for vesting have a much smaller chance of achieving
vested status.
Several factors indicate that excessive cost does not exist and
should not serve as a barrier to bringing the plans which do not now
meet ERISA vesting standards into conformance with the "Ten
Year of Service" vesting rule. First, nearly all of the employees in
such plans already have vesting after 15 or 20 years of service. Second,
experience studies obtained from actuarial reports supplied to the
Pension Task Force indicate that the number of employees terminating
with ten to 15 (or 20) years of service is typically less than 10 percent
of the total number of employees who now terminate employment
without vesting. Termination rates are usually much lower in police
and fire plans, which are the plans most likely to have restrictive
vesting or no vesting, than is the case in plans covering other categories
of employees. These first two factors suggest that while a small minor-
ity of employees would benefit from the extension of ERISA vesting
standards to the plans not now meeting them, the employees benefiting
would be those having substantial periods of service.
A third factor which reduces the employer's cost of vesting under
public employee retirement systems is the contributory nature of
most plans. For example, accumulated employee contributions of, say,
5 percent of pay may be sufficient to "purchase" (depending on
length of service and age at retirement) 20 percent to 30 percent of
the total retirement benefits for an employee in a typical plan (see
Chapter E). For an employee with vested benefits who terminates at
an age considerably before normal retirement age, accumulated em-
ployee contributions may "purchase" over 50 percent, and in extreme
cases 100 percent, of the employee's vested pension benefit. A study
of the cost of vesting commissioned by the Pension Task Force shows
that employer pension costs are increased by 3 percent to 6 percent
if 10-year vesting is extended to noncontributory plans with turnover
experience typical of public pension plans.3 The contributory nature
of public pension plans and the other factors discussed above suggest
that the relative cost increase for most public plans should be less
than one-half this level.
As mentioned at the beginning of this section, ERISA requires
100 percent vesting of the portion of an employees' accrued benefit
derived from his own contributions. For defined benefit plans, the
portion of the employee's accrued benefit attributable to employee
contributions is derived (in accordance with Section 204(c) of ERISA)
by multiplying the employee's accumulated contributions by an
actuarial factor which converts the lump sum accumulation into an
annual pension amount. When an employee terminates employment
and receives, whether voluntarily or otherwise, a lump sum distri-
bution instead of a deferred pension benefit based on his own con-
tributions, the lump sum is calculated as the present value of the
annual pension benefit. The lump sum may differ from the accumu-
lated amount of the contributions made by the employee. Although
final regulations under ERISA have not been issued in this area, it
2 For example, see the experience for group 3 of Appendix A, "Estimates of the Cost of
Vesting in Pension Plans," by Howard E. Winklevoss. Committee print, Committee on Edu-
cation and Labor, U.S. House of Representatives, 93d Cong., 1st sess.
3 See footnote 2, vesting costs for group 3 are shown on p. 18.
90
is likely that the lump sum return of employee contributions will
usually have to be accompanied by the payment of interest, at least
on a partial basis.
If the above ERISA rules were to apply to public employee retire-
ment systems, over one-half of the plans covering over one-fourth
of all state and local government employees would probably fail to
meet the minimum standards (see Table 20 in Appendix I). Nearly
50 percent of the plans covering almost 18 percent of the total number
of employees do not pay interest on mandatory emplo37ee contribu-
tions. Likewise, the Federal Civil Service Retirement System permits
the return of employee contributions without interest to persons
who separate with at least 5 years of service. Presently, interest is
credited at the rate of 3 percent on the contributions which are re-
turned to federal employees who separate with less than five years
of service.
Surprisingly, over 12 percent of the total number of local police
and firefighters are in plans which do not permit the return of employee
contributions upon separation before retirement. Among the different
categories of public employees, teachers are the most likely to be
covered by plans meeting the ERISA-like interest rule, while police
and firefighters are the least likely to be so covered.
Another provision in ERISA prevents the forfeiture of the vested
portion of the employee's accrued benefit derived from employer
contributions in the event that an employee withdraws his own con-
tributions. An exception to this rule (see ERISA section 203(a) (3)(D))
applies to an employee who is less than 50 percent vested. While the
vested benefits of such an employee may be forfeited at the time he
withdraws his own contributions, the plan must contain a "buy back"
provision permitting the employee to fully restore the forfeited bene-
fits upon the repayment of his contribution plus 5 percent interest.
Less than 3 percent of the total number of state and local govern-
ment employees are covered by plans containing an ERISA-like
provision prohibiting the forfeiture of vested benefits at the time an
employee withdraws his own contributions (Table 20 in Appendix I
also shows the federal plans to be lacking in this regard). However,
85 percent of the state and local government employees and 100 per-
cent of the federal employees are covered by a "buy back" provision
permitting employees to redeposit withdrawn contributions in order
to restore prior service credits. Among the different categories of
employees, state legislators, 93 percent, are the most likely to be
covered by "buy back" provisions while police and firefighters, 62 per-
cent, are the least likely to be so covered.
As discussed in Chapter C, the Pension Task Force survey found
many plans to have relatively few terminated vested employees on
their deferred pension rolls. This suggests that the withdrawal of
employee contributions by terminated vested participants is a prac-
tice that is widespread among public pension plans. Because accrued
benefits related to employer contributions are forfeited in nearly all
such cases, hundreds of thousands, perhaps millions, of public em-
ployees have lost valuable benefits by withdrawing their own contri-
butions. This unfortunate situation exists because most public em-
ployees are not told that they may be forfeiting benefits of much
greater value when they elect to withdraw their own contributions.
91
In order to make vesting more attainable and meaningful, ERISA
contains certain rules relating to service, "breaks-in-service", and the
form and payment of benefits.
Generally, ERISA requires that all of an employee's years of service
(employment) with the employer or employers maintaining the plan
be credited for vesting purposes (see ERISA section 203(b)). Most
public pension plans also follow this rule, although just over 25 per-
cent of all federal, state, and local plans do not credit pre-participation
service for vesting purposes (see Table 24 in Appendix I) . Because of
the generally non-restrictive participation rules under public pension
plans (as discussed in the previous section), the provision in 25 per-
cent of the plans defining years of service to be years of participation
is not overly restrictive when compared with ERISA.
This is especially so in light of the fact that an exception to ERISA's
general rule permits service before the age of 22 to be excluded for
purposes of the "10- Year Service" and "Graded 15-Year Service"
vesting rules.
Another exception to ERISA's general rule that all service be
credited for vesting purposes permits plans to disregard service prior
to a break-in-service as defined by the minimum standards. Generally,
the break-in-service rules prevent short periods of interrupted em-
ployment, whether voluntary or involuntary, from being used to unduly
frustrate the achievement of an employee's vested status. The ERISA
rule-of -parity prevents a plan from disregarding prior service for a
non-vested employee until the 1-year breaks-in-service equal "or exceed
the prior years of credited service.
Nearly 90 percent of the state-administered retirement systems,
like the Federal Civil Service Retirement System, aggregate all
service and, thus, do not disregard prior service because of a service
break (see Table 24 in Appendix I). In contrast, over 46 percent of the
locally-administered plans and 17 percent of the federal plans require
that employment be continuous until vesting is achieved. Slightly
under 10 percent of all plans disregard prior service for vesting
purposes when a break-in-service occurs which is between 1 and 5
years in length.
Generally ERISA requires that deferred vested benefits be payable
no later than normal retirement age (see Chapter E) . In the case of a
plan which provides for early retirement for active participants, a
terminated vested participant is entitled to receive his benefits (actu-
arially reduced) at the early retirement age provided the early retire-
ment service requirements are also met. Considering the fact that
deferred vested benefits are payable at 65 or before in all public
pension plans, with nearly 75 percent of the employees permitted to
receive them at age 60 or earlier, it would appear that the above
ERISA requirement is already being met for most public employees
(see Tables 21 and 22 in Appendix I).
A final provision of ERISA which relates to vesting is applicable to
governmental pension plans which desire to be qualified under the
Internal Revenue Code (see Internal Revenue Code section 411(e)).
This provision states that the pre-ERISA Internal Revenue Code
sections 401(a)(4) and (7) continue to apply to governmental pension
plans. Generally, these rules require that contributions and benefits
not discriminate in favor of the highly compensated employees over
74-3G5— 7S 7
92
the rank and file employees and that the accrued benefits of all
employees be vested to the extent funded in the event of a plan
termination or complete discontinuance of contributions.
In the past, the Internal Revenue Service has challenged the quali-
fied status of some governmental pension plans for alleged violations
of the non-discrimination requirement of IRC section 401(a)(4). For
example, in 1975 the IRS threatened the Missouri PERS with a $5
million tax lien in the event the system did not come into compliance
with the Internal Revenue Code.4 The issue involved the plan's
earlier vesting for state executive officers and legislators (4-year and
6-year vesting, respectively) as opposed to the 10 years of service
required of other state employees for vesting. The earlier vesting of
executive officers, legislators, and judges is a practice commonly
found in many states other than Missouri. The manner in which the
IRS will resolve this and other issues regarding the application and
enforcement of Internal Revenue Code provisions relating to govern-
mental pension plans remains to be seen. See Part II of this report for
a discussion of the current position of the IRS in regard to these and
other matters affecting governmental plans. The current and past
confusion suggests that a legislative remedy may be necessary to
clarify public policy in this area.
PORTABILITY PROVISIONS
The preservation of public employee pension credits takes on several
different forms. The complete transfer of pension credits through par-
ticipation in Social Security is the most important portability protec-
tion for public employees, as it is for employees in the private sector.
However, over 30 percent of the employees of state and local govern-
ments and 55 percent of the employees of the federal government
remain outside the scope of Social Security coverage (see Chapter B).
With regard to the preservation of the pension credits earned by
public employees under their retirement systems, vesting is presently
the most important means of such benefit protection. However, as
discussed in the previous section, even vesting is not universally found
among public employee retirement systems.
While Social Security coverage and vesting serve as the only means
of retirement benefit protection for an employee who leaves public
employment for a job in private industry, other means of pension
portability exist for employees who transfer to employment within
the governmental sector. These other forms of portability are usually
more valuable to the employee than is vesting alone. This is because,
for purposes of the pension benefit computation, the service credits
which are transferred in accordance with the portability scheme are
ordinarily used in conjunction with the employee's final average wages
at retirement, and not the generally lower wages at the time of transfer.
It can be seen (Table D3) that nearly 82 percent of all state and local
government employees are covered by plans permitting some form of
inter-governmental pension plan portability. Only 8 percent of the
plans covering 3 percent of the total number of state and local govern-
ment employees give automatic credit to employees for service ren-
dered with other governmental emplo3~ers without requiring the em-
ployee or former employer to contribute or reciprocate in some manner.
* "Pensions and Investments,"' Mar. 31, 1973.
93
Rather than receiving prior service credit automatically and with-
out cost, nearly 24 percent of the state and local government employees
may, at their option, receive credit for prior in-state government
service by meeting some or all of the benefit cost of the service credit
transfer. Only 9.2 percent of such employees are extended this option
for out-of-state government service. Among the different categories of
employees, teachers are the most likely to be covered under this type
of service credit cost-sharing option. Nearly 70 percent of all local
public school teachers and 13 percent of the teaching staffs of public
colleges and universties are permitted to purchase both in-state and
out-of-state service credits, usually by making contributions equal to
those they would have made had they always been covered by the
new system.
Another arrangement whereby portability is extended to public
employees is through reciprocal agreements entered into by two or
more retirement systems. Such agreements are usually found between
plans in the same state, although several teacher plans have made
reciprocal arrangements with plans outside their own states.
Over 70 percent of all public employees are covered by plans having
reciprocal agreements with one or more plans within their respective
states. Such arrangements are more prevalent among plans admin-
istered at the state level (20.8 percent) than among those administered
at the local government level (8.3 percent). The reciprocal arrange-
ments can take many forms as to the manner in which credited
service enters into the pension benefit computation and as to how
the ultimate pension benefit costs are shared. Approximately 55
percent of the reciprocal agreements call for the transfer of funds
between systems. A statutory provision in one state requires that
the pension benefit costs for retirees who have accumulated service
under more than one plan be prorated based on the service in each.
Table D3 shows that while 81.5 percent of all state and local govern-
ment employees are covered by some form of inter-plan portability
provision, only 2.4 percent are not covered by amr portability or
vesting provision. Among the different system coverage categories,
police and fire plans are the most likely to lack portability and vesting
(58.7 percent), while all the plans covering teachers have some form
of vesting or portability.
94
95
The crediting of in-state service takes place in ways other than
through the inter-plan portability arrangements discussed above.
Nearly three-fourths of the total number of state and local govern-
ment employees participate in "multiple employer" pension plans
which give employees service credit for employment with any of the
employers contributing to the system. Multiple employer pension
plans may be city-wide, thus providing pension portability for inter-
occupational employment, or they may be statewide, whereby port-
ability extends to state and local service or to service within a par-
ticular occupational group (which in turn is limited in some cases to
local government service). One state, Hawaii, has provided complete
intranstate portability for all its state and local government employees
through the process of consolidating several plans into one retirement
system (see Appendix VI) .
The extension of military service credit is another aspect of inter-
governmental pension portability which is commonly found among
state and local pension plans. Approximately one-third of the plans,
covering 90 percent of all employees, have various provisions giving
employees pension credit for periods of employment interrupted by
military service. As discussed in the section on the Military Selective
Service Act (see Part II of this report), the recent Supreme Court
decision in Alabama Power Company v. Davis may mean that all
state and local government pension plans will have to grant a returning
veteran with military service credit for vesting and benefit accrual
purposes.
The extent to which service credits are transferable among the 68
retirement systems maintained by the federal government and its
agencies and instrumentalities is shown in Appendix IX. The U.S.
General Accounting Office has pointed out several inconsistent prac-
tices regarding the transfer of credit from one federal system to an-
other (see Appendix XII) .
A final note regarding the portability of public pensions relates to
an ERISA provision permitting tax-free rollovers to facilitate the
transfer of pension funds (but not service credits). Lump sum distri-
butions from a pension plan, whether public or private, which is
qualified under section 401(a) of the Internal Revenue Code may be
reinvested on a tax-free basis within 60 days in another qualified
plan or in an individual retirement account (see ERISA section 2002).
An aspect of importance to public employees, many of whom make
mandatory pension contributions, is that the lump sum distribution
must be reduced by the amount of employee contributions before it
can be rolled-over on a tax-free basis.
RISK OF PUBLIC PENSION BENEFIT LOSS OR REDUCTION
Because of the widespread losses which resulted prior to ERISA
when private pension plans terminated with insufficient assets to pay
vested benefits, Title IV of ERISA created the Pension Benefit
Guaranty Corporation to guarantee vested benefits through a federal
program of plan termination insurance. From the limited informa-
tion available, there is no conclusive evidence that widespread benefit
losses have occurred due to public pension plan terminations.
Information from the Pension Task Force survey shows that nearly
6 percent of the existing public employee retirement systems were
96
created after their old systems were disbanded (see Table 3 in Appen-
dix I). If the former plans were qualified pension plans under section
401(a) of the Internal Revenue Code, then the accrued benefits under
such plans should have been vested to the extent funded at the time
of termination (see the discussion of this point under the previous
section on vesting). The extent to which benefits were actually pro-
tected in this manner is problematic. The Internal Revenue Service
has apparently followed a policy of non-enforcement in this area in
the past and, therefore, was unable to supply any information in
regard to such terminations (see Appendix X for the IRS reply to a
request for information on public pension plan terminations).
Several public employee retirement systems were terminated be-
tween 1951 and 1955 when Social Security coverage was first made
available to state and local government employees not otherwise
covered under a state or local government plan. For example, in 1951
the South Dakota State Teachers' Retirement System was liquidated
when the state teachers were first brought under Social Security
coverage. At that time vested employees were permitted to draw
their pensions while non-vested employees were refunded their own
contributions and a portion of the employer's contributions.5
In 1951 Iowa also terminated and reorganized its state pension
fund.6 In total, over 15 percent of the existing state-administered
pension plans and 19 percent of the locally-administered plans were
created either through merger or a major plan restructuring (see
Table 3 in Appendix I). As a result of the past restructuring and
consolidation of public pension plans, at least 395 plans have been
"closed" to new members. The extent to which benefits under such
plans have been "frozen" or even reduced is iinknown.
The evidence does suggest, however, that public employees do
face the risk of pension benefit reductions or other benefit curtail-
ments due to reasons other than plan termination. In this regard,
almost 8 percent of the state and local government pension plans,
covering 18 percent of the total number of active participants, re-
sponded affirmatively to the following question: "Have retirement
benefits (or other system features) been curtailed or reduced for any
part of your system in the last ten years?" (see Table 41 in Appendix I).
A number of plans responded that various pension plan features
were scaled back only for those employees who were hired after the
effective date of the plan amendment. For example, plans in several
states were amended so that for new employees — (1) the normal
retirement age was increased from age 55 to age 62, (2) the salary
for benefit computation purposes was changed from the last year to
a final three year average, (3) the minimum guaranteed benefit was
<l continued, (4) a new maximum benefit of 60 percent of final average
salary was introduced, (5) the eligibility requirements were increased
from three months to one year of service, or (6) the benefit formula
was "integrated" with Social Security.
vSome pension plans at the federal, state, and local levels were
also amended in a way so as to reduce the value of past and/or future
pen -ion benefit accruals for presently active employees. For example,
6 Information obtained from Mr. Boyd Roseland of the South Dakota Retirement System
in a November 1077 request of the Congressional Roseareh Sorviee.
" Legislative Retirement Study Commission : Report to the 1973 Legislative Session of the
State of Minnesota, p. 2.
97
several plans in both Colorado and Connecticut indicated that dis-
ability benefits for future disabilit}^ annuitants were reduced and that
the definition of normal retirement age was changed to require a
higher attained age or greater lengths of service for retirement. In
Connecticut, accrued pension benefits were significantly reduced for
some terminated vested and active employees having less than 25
years of service.7 The accrued benefits related to employee contribu-
tions were reduced for the employees in one Louisiana plan when the
payment of interest on employee contributions was discontinued.
Future benefit accruals were also reduced in several federal plans
covering non-appropriated fund personnel. Most recently, the so-
called 1-percent ' 'kicker" to the automatic cost-of-living adjustment,
which would have applied to all future benefit payments to the
employees and annuitants covered under the Federal Civil Service
Retirement System, was removed legislatively.
The evidence suggests that the greatest risk of pension benefit
reductions or other benefit curtailments is related to governmental
financial problems and the underfunding of public pension plans. In
some cases pension plan insolvency has resulted. Extreme financial
problems confronting the pension plans in several states have in the
past resulted in temporary and, in a few cases, permanent benefit
losses for some public employees. For example, in 1972 the Hudson
County, New Jersey Employees Pension Fund was temporarily placed
in receivership by court order when bankruptcy appeared imminent
because of "gross and fraudulent mismanagement".8 The court ap-
pointed receiver terminated the pensions of approximately 240 persons;
and about 120 of these persons subsequently brought suit to have the
receiver's actions reversed.
In 1970, the city of Hamtramck, Michigan lacked the pension
funds to meet the pension checks for 206 retired policemen, firemen,
and widows.9 The Advisory Commission on Intergovernmental Rela-
tions concluded that "the city of Hamtramck went through a financial
emergency and a form of receivership primarily because of its lack of
sound financial management practices, its exceedingly high police
and fire pension obligation, and because State statutes limited its
ability to raise sufficient revenues to meet its obligations." 10
The underfunding and financial problems which occurred in Ham-
tramck are not unique. Temporary benefit suspensions (having root
causes similar to those in Hamtramck) have also occurred in the
past among the police and fire systems in Arkansas, Mississippi, and
Oklahoma. In the mid-1960's the police and firemen's funds in Lake-
wood and Toledo, Ohio also ran into financial problems and were
unable to meet current benefit pa3Tnents.n In an attempt to correct
local pension plan underfunding, the Ohio state legislature subse-
7 U.S. Congress, House Committee on Education and Labor, Subcommittee on Labor
Standards, the Public Employee Retirement Income Security Act of 1975 : Hearings on
H.R. 9155 and H.R. SOS (Washington, D.C., U.S. Government Printing Office: 1976), pp.
510-512.
8 "'Hudson Pension Unit Put Into Receivership Under Court Order," New York Times,
Mar. 7, 1970.
9 Detroit Free Press, Mar. 7. 1970.
10 U.S. Government, Advisory Commission on Intergovernmental Relations, "City Financial
Emergencies: The Intergovernmental Dimension" (Washington, D.C, U.S. Government
Printing Office : 1973), p. 40.
11 National League of Cities. National Association of Counties, and U.S. Conference of
Governors, Labor Management Relations Service. "Pensions for Policemen and Firemen :
Special Report," by Philip M. Dearborn, Jr. (Washington, D.C. : 1975).
98
quently established an actuarially funded statewide pension plan for
all police and firemen. However, in states other than Ohio, 17% of the
total number of locally-administered police and fire pension funds
continue to operate on a current disbursement (pay-as-you-go)
financial basis.
At the state level, in 1935 the Minnesota state plan "f ailed
partially".12 At that time pensions for state employees were reduced,
although in 1939-40 the state legislature restored the benefits to
prior levels.
It should be noted that the foregoing discussion relates primarily
to public pension plans of the defined benefit type. The accrued pension
benefits of employees in defined contribution plans face certain other
risks of loss. For example, the variable annuity portion of the benefits
for the teachers who participate in public university and college
pension plans which are funded through the College Retirement
Equities Fund affiliate of the Teachers Insurance and Annuity Asso-
ciation are adjusted in accordance with changes in the market value
of the CREF common stock fund. Thus, it is not the employer, but
the emplo}ree or retiree who assumes the risk of investment loss and
reaps the reward of investment gain under this type of variable annuity
plan. It might also be noted here that ERISA does not provide plan
termination insurance coverage to private pension plans of the defined
contribution type. Some public colleges and universities have estab-
lished defined benefit plans as a supplement to their TIAA-CREF
plans in order to guarantee employees a minimum pension regardless
of the investment experience of the employee's individual TIAA-
CREF account.
Presently the accrued pension benefits for participants in private
pension plans are protected in several ways under ERISA. First,
vested pension benefits, with certain limitations, are guaranteed in
the event of plan termination (ERISA Title VI). Second, minimum
funding standards help insure that benefits will be paid under defined
benefit pension plans (ERISA Title I, Part 3). Third, accrued benefits
generally ma}^ not be retroactively reduced by plan amendment
(ERISA Title I, Part 2).
Presently, no plan termination insurance program counterpart to
ERISA Title IV is applicable to public employee retirement systems
(except to the extent that a particular plan does not meet the definition
of "governmental pension plan", in which case it would be covered
by ERISA). The extent to which public employee pensions are pro-
tected by means of the past and present funding practices of the
governmental sponsors is fully discussed in Chapter G.
In comparison to the third provision of ERISA which serves to
protect the accrued benefits of private pension plan participants,
over 45 percent of the total number of state and local plans covering
nearly 69 percent of all active employees are subject to a constitu-
tional or other legal provision prohibiting the diminishment or impair-
ment of pension benefits (see Table 41 in Appendix I). In many states
the degree to which such provisions offer meaningful protection to
public employees and their accrued pensions remains unsettled.
However, the constitutional provision in Massachusetts prohibiting
12 Information obtained from Michael N. Thome, Chief Executive Officer. California State
Teachers' Retirement System in a November li>77 Pension Task Force request.
99
the impairment of benefits appears to have been successful in pre-
venting reductions in not only the accrued benefits but future benefit
accruals of present employees. On the other hand, recent develop-
ments in Illinois, Michigan, and Tennessee indicate that constitutional
and other legal provisions may be totally ineffective in forcing state
and local governments to raise the necessary funds to meet pension
benefit payments or statutory funding requirements, particularly
when the stability of the government might be impaired. The reader
should refer to Chapters F and G and Parts II and III of this report
which discuss these constitutional and legal provisions in more detail.
At the federal level, 50 percent of the governmental plans covering
2.8 percent of the total participants are subject to a constitutional or
other legal provision prohibiting the diminishment or impairment of
pension benefits. The pensions of the President and the federal
judiciary are protected constitutionally while the plans covering
employees of the Federal Reserve Board and Banks, the Federal
Home Loan Banks, the Federal Home Loan Mortgage Corporation,
and the Tennessee Valley Authority apparently have plan provisions
preventing reductions in accrued pension benefits. The extent to
which the federal government has a legal obligation to guarantee
the pension plans of the above, as well as other, quasi-governmental
organizations remains uncertain. For example, it is unclear to what
extent the federal government has a legal obligation to fund the
$226 million unfunded accrued liability of the several federal pension
plans covering nonappropriated fund personnel in the event the
nation's military commissaries and post exchanges are closed, as
has been suggested from time to time. Significantly, given recent
developments, specific constitutional provisions prohibiting benefit
curtailments do not apply to the plans covering the military and
federal civilian service. Also, there is presently no direct federal
obligation to guarantee the pension funds of state and local govern-
ment employees. This situation may change, however, to the extent
that the federal government becomes the ultimate guarantor of state
and/or local government obligations purchased by local government
pension funds, as has recently been suggested as part of the overall
federal financing scheme to help New York City avoid bankruptcy.
SUMMARY AND CONCLUSIONS
1. Retirement System Participation Requirements
With the exception of provisions relating to the coverage of part-
time employees, the eligibility requirements of public employee
retirement systems generally permit earlier participation than is
required under ERISA. Only 2 percent of the public employees must
meet age and service requirements more restrictive than those permit-
ted under ERISA.
The one aspect of participation in which public pension plans fall
considerably short of the ERISA minimum standards involves the
coverage of part-time employees. Because many plans require a
restrictive number of hours of service for participation, part-time
public employees make up the largest segment of the public sector
workforce lacking pension coverage.
100
The "breadth-of-coverage" provision of the Internal Revenue Code
(e.g. section 401(a)(3) as in effect prior to ERISA) continues to apply
to qualified governmental pension plans. It is estimated that few, if
any, large governmental plans would have problems meeting this
standard, although many small plans may have to be amended to
include part-time employees in order to meet the Internal Revenue
Code qualification requirements.
2. Retirement System Vesting Requirements
Nearly 71 percent of the total number of public employee retirement
systems, covering over two million state and local government em-
ployees, do not presently meet ERISA's minimum vesting standards.
However, less than 3 percent of the total number of state and local
government employees are in plans with no vesting — nearly all such
employees are in local police and fire department plans. The 2.2
million members of the federal uniformed services remain the largest
group of employees, either inside or outside of government, with no
pre-retirement vesting.
The most typical vesting provision among public pension plans is
100 percent vesting after 10 years of service, as is the case among
private pension plans. Plans with vesting after five years or less is
also common, covering in this case over 38 percent of the total number
of state and local government employees and nearly all federal
civilian employees.
Several factors — low turnover, the presence of at least some vesting,
and the contributory nature of most plans — indicate that excessive
cost should not serve as a barrier to bringing those plans which do not
presently meet ERISA minimum vesting standards into conformance
with such rules. However, one ERISA provision that could prove
more costly to public pension plans prohibits the forfeiture of vested
benefits derived from employer contributions in the event employee
contributions are withdrawn. The vested benefits of less than 3
percent of the total number of federal, state, and local government
employees are presently protected in this manner. Also, an ERISA-
like provision generally requiring that interest be paid on employee
contributions could increase pension costs significantly for a majority
of the federal, state, and local pension plans.
While most state-administered and federal pension plans aggregate
all of an employee's service for vesting purposes (regardless of the
number or length of the breaks-in-service that ma}^ occur), the majority
of the locally-administered plans require an employee's service to be
continuous or to meet other break-in-service rules which are not
permitted under ERISA.
Public employee retirement s}rstems which seek the tax benefits of
a qualified plan under section 401(a) of the Internal Revenue Code
(IRC) must currently meet the vesting related requirements of certain
pre-ERISA sections of the IRC (i.e. the non-discrimination and non-
reversion provisions that were applicable to both private and public
pension plans prior to ERISA). In the past, the Internal Revenue
Service has challenged the qualified status of some governmental
plans for alleged violations of the non-discrimination requirement of
the IRC (e.g. for providing earlier vesting for legislators and executive
officers than for other employees). In this regard, it might be noted
101
that many states currently provide earlier vesting and larger benefit
accruals for executive officers, legislators, and judges than for other
employees. The past and current confusion related to the non-dis-
crimination provisions of the Internal Revenue Code suggests that a
legislative remedy may be necessary to clarify public policy in this
area.
3. Retirement System Portability
The preservation of public employee pension credits takes on several
different forms. The most important portability protection for public
employees, as for private sector employees, is obtained through
participation in Social Security. However, over 30 percent of the
employees of state and local governments and 55 percent of the em-
ployees of the federal government remain outside the scope of Social
Security coverage.
While Social Security coverage and the vesting of public pension
benefits serve as the only two means of retirement benefit protection
for an employee who leaves public employment for a job in private
industry, other means of portability exist for employees who change
jobs within the government sector. Nearly 82 percent of all state and
local government employees are covered by plans having some form of
pension plan portability of intra-state government service. In contrast,
less then 13 percent of such employees are covered by plans extending
pension credit for out-of-state government service. However, nearly
three-fourths of all public school teachers may elect to receive credit
for out-of-state service, usually by making employee contributions at
a stipulated rate for each year of service credited.
The crediting of in-state government service is also facilitated for
nearly three-fourths of the total number of state and local government
employees who participate in multiple employer pension plans which
accumulate an employee's service credit from employment with any
of the employers contributing to the system. In regard to federal
retirement systems, the U.S. General Accounting Office has pointed
out several inconsistent practices regarding the transfer of credit
from one plan to another.
Approximately one-third of the state and local plans have various
provisions giving employees pension credit for periods of employ-
ment interrupted by military service. The possibility that all
pension plans should contain such a provision is discussed.
4. Risk of Public Pension Benefit Loss or Reduction
Unlike the situation prior to ERISA when private pension plan
terminations resulted in widespread pension benefit losses, there is
no conclusive evidence that widespread benefit losses have occurred
as a result of public pension plan terminations.
However, survey information does show that nearly 6 percent of
the existing public employee retirement systems were created after
pre-existing systems were disbanded. The extent to which the tax-
qualified plans followed the Internal Revenue Code requirement
that accrued benefits under such terminated plans be vested to the
extent funded is problematic. In the past the Internal Revenue
Service has apparently followed a policy of non-enforcement in this
area, and was, therefore, unable to supply any information in regard
to public pension plan terminations.
102
The evidence shows that public employees do face the risk of pension
benefit reductions or other benefit curtailments due to reasons other
than plan termination. For example, 8 percent of the pension plans at
federal, state, and local levels covering 18 percent of the employees
have been amended to reduce the value of past or future pension bene-
fit accruals for active employees, while other plans have scaled back
certain plan features for new employees only.
It appears that the greatest risk to public employees of having
pension benefits reduced or other benefit features curtailed relates to
governmental financial problems and the underfunding of public
pension plans. Mismanagement, financing limitations, exceedingly
high pension obligations, and financial emergencies have all con-
tributed in the past to situations of pension plan insolvency or near-
insolvency. As a result of these situations, some public employees have
suffered temporary and, in a few cases, permanent benefit reductions.
While nearly 69 percent of all state and local government employees
are covered by pension plans subject to a constitutional or other legal
provision prohibiting the diminishment or impairment of pension
benefits, in many states the degree to which such provisions offer
meaningful protection to public employee pension benefits remains
unsettled.
Chapter E — PERS Benefit Structure and Income
Replacement Levels
Since there are so many public employee retirement systems with
varied provisions for different occupational groups, it is not entirely
possible to describe the "typical" PERS plan. However, some gener-
alizations can be made about certain features of various types of
plans such as state retirement systems for general state employees,
large municipal retirement systems, plans covering policemen and
firemen, and large state-administered s}7stems for teachers. These in
turn can be compared with the Federal Civil Service Retirement
System and the Military Retirement System. This chapter presents
and compares various features typically found in the above systems.
Also discussed is the extent to which public pension plans meet ERISA
requirements in regard to normal retirement age, joint and survivor
annuities, benefit accruals, and benefit limitations. An analysis of
public pension plan benefit levels in terms of gross and net income
replacement is also presented. Appendix I contains detailed informa-
tion on normal, optional, and early retirement age (Table 25), dis-
ability benefits (Tables 27-30), reductions in disability benefits
(Table 31), pre-retirement death benefits (Table 32), post-retirement
death benefits (Table 33), cost-of-living adjustments (Table 40), and
pension benefit formulas and levels (Tables 36-39, and 42-46).
RETIREMENT AGE
Generally, ERISA provides that a private pension plan may not
have a "normal retirement age" (age and service condition when
pension benefits are payable without reduction on an actuarial or
other basis) greater than age 65, or in the alternative, the plan may
provide for normal retirement as the later of age 65 or the 10th
anniversary of the time an employee commences participation in
the plan (ERISA Section 206). It can be seen (Table El) that public
employee retirement systems generally meet this requirement and
provide for much earlier retirement. General state and municipal
employees can often retire as early as age 60 or 62 with policemen
and firemen eligible for normal retirement at age 50 or 55. Because
of ERISA's participation requirements (see Chapter D) emplo3^ees
in private pension plans cannot be required to have more than five
years of service at retirement unless the plan adopts the alternative
"10 year anniversary" definition of normal retirement age. A few
public pension plans require more than ten years of service for retire-
ment and would therefore fail to meet ERISA's requirements in this
area. The Military Retirement System and over 60 percent of the
local police and fire plans, which usually require 20 years of service
for retirement, would also fail to meet ERISA's service provisions
relating to retirement.
While ERISA does not require private pension plans to provide an
optional normal retirement age where an individual may retire at an
(103)
104
earlier age without incurring an actuarial reduction, public employee
plans (with the notable exception of police and fire plans as well as
the military) typically provide an earlier optional normal retirement
age requiring a greater number of years of service. A number of plans
covering state and municipal employees provide for optional retire-
ment after 30 years of service without an age requirement. Employees
of large municipal governments can often retire at age 60 or earlier if
they have completed ten years of service. A number of plans have
several optional normal retirement age requirements along the lines
of the Federal Civil Service Retirement System (e.g. at age 62 with
5 years, at age 60 or later with 20 years, or age 55 or later with 30
years of service). There is no optional normal retirement age for the
military system nor for most plans covering policemen and firemen.
In the military an individual is generally required to work 20 years
regardless of age in order to qualify for a pension. This is often the
case in plans covering policemen and firemen although participants in
these plans may also have to also attain age 50 or 55. However, once
these conditions are met, individuals may immediately start to draw
their unreduced pensions.
Uniformed service plans (police, fire, and military) and the federal
Civil Service Retirement System do not have provisions for early
retirement (with an actuarial or other reduction) . Generally, the only
plans that provide for early retirement are state plans for general
employees and large state-administered plans for teachers. Early
retirement is usually permitted at any age for teachers in public colleges
and universities who are members of plans funded through the
Teachers Insurance and Annuity Association and its affiliate, the Col-
lege Retirement Equities Fund. This is because the plans are fully-
funded, defined contribution plans providing complete portability.
The amount of the pension, however, is dependent upon the amount in
the individual's account together with related earnings.
Some pension plans in the public sector, as in the private sector,
provide for mandatory retirement at age 65 or later, such as at age
68 or age 70. Less than 10 percent of the public plans, however,
provide for mandatory retirement before age 65. Only 13 large plans,
having 1,000 or more active members, were found to have a mandatory
retirement age of less than age 65 (usually age 50, 60, or 62). About
425 smaller plans, principally police and fire plans, also require re-
tirement earlier than at age 65. In total approximately 90,000 persons
are presently effected by such provisions. See Part II — Age Dis-
crimination in Employment Act for a discussion of the federal law
which may require changes to be made in the plans which have
mandatory retirement ages.
105
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107
DISABILITY BENEFITS
ERISA does not require private pension plans to provide disability
benefits. However, if a private pension plan integrates the benefit
formula with Social Security benefits, the pension plan cannot further
reduce disability benefits that are being paid by virture of subsequent
increases in Social Security benefits (ERISA section 206(b)).
Nearly all public employees are covered under plans offering bene-
fits in connection with total and permanent service-connected dis-
ability. Some plans — particularly the Civil Service Retirement System
and many large state-administered plans for teachers — require 5 years
of service before individuals are eligible for benefits. Surprisingly,
nearly one-sixth of the police and fire plans do not have provisions for
total service-connected disability. Similarly, about one-third of the
police and fire plans do not provide benefits in case of total and per-
manent non-service connected disability. However, most other public
employees are in plans providing total and permanent non-service
connected disability benefits.
While the Military Retirement System and plans for higher educa-
tion teachers provide partial service-connected and non-service -
connected disability benefits, other PERS plans typically do not offer
partial disability benefits whether they are service-connected or not.
The absence of disability benefits from a public pension plan does
not necessarily mean that the employees lack disability protection.
About 70 percent of the state and local government employees as well
as the federal military are covered under the Social Security disability
program. Disability protection for other employees may be provided
through private disability insurance policies. Public employees may
also be covered under workmen's compensation laws.
About one-half of the state general employee and large municipal
employee plans reduce plan provided disability benefits by at least a
portion of the benefits disabled employees receive under Social Security
or workmen's compensation programs. However, teacher plans (par-
ticularly higher education plans) and police and fire plans usually do
not reduce disability benefits on account of the receipt of other bene-
fits. Disabled federal civil service employees do not have their benefits
reduced on account of the receipt of other disability benefits. How-
ever, if the disabled federal employee is eligible for workmen's com-
pensation, the employee can receive either workmen's compensation
benefits or civil service disability benefits, but not both.
PRE-RETIREMENT DEATH BENEFITS
ERISA provides that an employee's rights to benefits attributable
to his own contributions may not be forfeited, even upon death. On
the other hand, a private pension plan may provide that an employee's
vested rights to benefits attributable to employer contributions may
be forfeited on account of the employee's death (ERISA Section
203(a)(3)). However, ERISA requires a plan to offer an emp^ee an
opportunity to elect a joint and survivor annuity which would become
payable in the event the employee died in active service after becom-
ing eligible for early retirement (ERISA Section 205).
74-365—78 8
108
The majority of all public employee pension plans return members'
contributions in the case of death before retirement. However, over
one-third of the police and fire plans do not return members' contri-
butions. In addition most PERS plans offer a spouse survivor annuity
or a lump-sum payment on account of death before retirement. In
many cases the pension plan survivor's benefits may be payable in
addition to the Social Security survivor's benefits for which the covered
survivor may be eligible.
POST-RETIREMENT DEATH BENEFITS
ERISA requires that when a private pension plan provides for a
retirement benefit in the form of an annuity (and the participant has
been married for one year), the plan must offer a joint and survivor
annuity unless the employee specifically elects not to take the benefit
in this form (ERISA section 205). With the exception of many police
and fire plans, most public pension plans have provisions for joint
and survivor annuities. Usually the joint and survivor options are
not automatic as is required by ERISA in the case of private plans.
On the other hand, over one-fifth of the state and local pension plans
provide an automatic survivor annuity for which the participant is
not assessed an actuarial charge.
POST-RETIREMENT COST-OF-LIVING ADJUSTMENTS
In the past decade there has been a growing trend in the number
of public plans offering post-retirement cost-of-living adjustments.
This is particularly true of large plans such as state-wide plans and
those of major cities. This development was most likely encouraged
by the rapidly rising prices in recent years and the desire to have
retirement income keep pace to some degree with these increases. A
strong precedent for postretirement adjustments was established in
1962 when the federal government incorporated automatic cost-of-
living provisions in the Civil Service Retirement System and the
Military Retirement System.
As shown in Table E2, over 95 percent of all federal, state, and
local government employees are in plans making one or more types
of post-retirement cost-of-living adjustments. While less than 3 per-
cent of the participants in large plans (i.e. those with 1,000 or more
active members) do not have the benefit of post-retirement cost-of-
living adjustments, 63 percent of the participants in small plans
(i.e. those having less than 100 active members) lack post-retirement
cost-of-living protection. Participants in locally^administered plans,
particularly police and fire plans, are the least likely to be covered by
provisions adjusting benefits to reflect cost-of-living increases.
While 98 percent of the federal employees are covered by plans
adjusting benefits automatically and without limit with increases in
the cost-of-living, less then 5 percent of the state and local govern-
ment employees are similarly treated. However, over 90 percent of
the state and local government employees are in plans which make
cost-of-living adjustments either automatically with a limit or on
an ad hoc, basis. Over 60 percent of the participants in state and local
government plans have their pensions adjusted on an ad hoc basis
(adjusted from time to time after special consideration by a retire-
109
ment board, legislature, or other official body). Over 45 percent of the
participants have their benefits adjusted each year by a constant
percentage (which may be unrelated to the actual rise in the cost-of-
living) or by a limited automatic adjustment related to the cost-of-
living (e.g. 50 percent of the cost-of-living or full cost-of-living but
no more than 3 percent).
Slightly under 13 percent of the state and local plan participants
have their benefits adjusted based on plan investment performance
(e.g. related to ' 'excess" earnings, or the performance of a common
stock fund such as the College Retirement Equities Fund) or on
another basis (e.g. through collective bargaining).
TABLE E2.— METHODS USED BY RETIREMENT SYSTEMS FOR COMPUTING POST-RETIREMENT
COST-OF-LIVING ADJUSTMENTS 1
[In percent]
Adjustment
based on
Automatic Automatic investment
adjustment adjustment perform- Total with
No Ad hoc without with ance or on one or more
Level and size of system adjustment adjustment limit limit other basis adjustments
EMPLOYEES
Federal Government .7 1.0 98.2 .6 .2 99.3
State and local government:
Large.. 1 2.8 63.1 4.6 46.6 12.4 97.2
Medium 28.4 20.5 5.5 23.2 25.9 71.6
Small 63.3 10.2 9.6 12.5 17.2 36.7
Total 4.5 61.1 4.7 45.5 12.9 95.5
PLANS
Federal Government 34.0 28.0 28.0 6.0 10.0 66.0
State and local government:
Large 12.7 38.8 7.3 37.7 18.9 87.3
Medium. 38.0 14.2 6.2 19.8 23.8 62.0
Small.... . 66.4 9.6 11.2 8.8 8.0 33.6
Total 57.5 12/7 10.1 12~9 lTi 42~5
i A plan may have more than 1 type of adjustment.
Note: Data from table 40 in app. I.
RETIREMENT BENEFIT FORMULAS
As discussed previously it is difficult, if not impossible to identify
the "typical" public pension plan regarding the age at which benefits
commence and the form in which they are paid. In like manner, the
benefit formulas of public pension plans are typified more by their
diversity than their sameness.
The amount of pension benefits payable to persons covered under
pension plans of the defined benefit type are calculated using such
factors as years of service, age, levels of compensation, form of com-
pensation, Social Security benefits, etc. On the other hand, the amount
of pension benefits payable under defined contribution plans depends
solely on the amounts contributed to the employee's individual ac-
count (including any earnings thereon). As discussed in Chapter B,
only 2.2 percent of the total number of state and local government
employees are covered under defined contribution plans, while 16
110
percent' are covered under "combination" plans having both defined
contribution and defined benefit features. Most combination plans
provide for a defined benefit pension financed by the employer and a
money-purchase pension based on the total value of the employee's
accumulated contributions at retirement.
Table E3 shows the distribution of the various types of defined
benefit pension plan formulas. Nearly 27 percent of the plans at all
levels of government are of the flat-benefit (percentage of compensa-
tion) type. Most of the plans of this type provide annual benefits of
50 percent of final compensation after 20 or 25 years of service. Flat-
benefit plans do not explicitly allocate total benefits to individual
years of credited service and, therefore, are found mainly among
plans lacking pre-retirement vesting — namely, the plans covering the
federal uniformed services and the plans covering local police and
firefighters.
In contrast to the flat-benefit formula, the total pension benefit
under a unit-benefit formula is equal to the sum of the benefit units
allocated to individual years of credited service. The unit benefit
for each year of service is usually computed as a rate, such as 2 per-
cent, times the employee's compensation base which varies consider-
ably from plan to plan as discussed later. The rate applicable to each
year of service may be invariant or may vary by age, length of service
or level of compensation. The annual accrued pension benefit under a
unit-benefit plan may, for example, be calculated for one person with
30 years of service as 30 times 2 percent, or 60 percent of the person's
5-year final average salary.
It can be seen (Table E3) that the single-rate unit-benefit formula
is the most frequently used formula among governmental plans except
for those covering police and firefighters. The rates that apply under
the single-rate plans are shown to vary from less than 1 percent to
over 2.5 percent (the highest rate found was 5 percent which was
applicable to only one plan). The single rate most commonly found
among police and fire plans is 2.5 percent, while 1 percent, 1.5 percent,
1.67 percent and 2 percent are the rates most commonly found among
all other single rate plans.
The variable-rate unit-benefit formula approach is utilized in 36
percent of the police and fire plans and in approximately 10 percent of
all other federal, state, and local pension plans. Under plans of this
type the rate applicable to the first "N" years of service may be higher
or lower than the rate applicable to the later years of service. The
first "N" years is usually 20 or 25, but may also be 10, 15, 30, etc. In a
small number of plans the rate per year of service was found to have
three levels of variation as in the Federal Civil Service Retirement
System {i.e. 1.5 percent for the first 5 years, 1.75 percent for the next
5 years, and 2 percent for all years of service thereafter). A few plans
included in the total shown as "other" in Table E3 were found to have-
rates varying according to age at retirement (e.g. 1.75 percent for all
years of service if retirement occurs at age 62, grading to 2 percent
for each year of service for retirements occurring at age 65).
The benefit accrual requirements of ERISA (ERISA section 204)
were included in order to prohibit unreasonably low benefit accruals
for short service employees as compared to the benefits accruing to
long service employees (called back-loading). Among the several
Ill
optional benefit accrual requirements under ERISA, one rule specifies
that for variable-rate unit-benefit plans the rate applicable to the
later years of service cannot be greater than 133)3 percent of the rate
applicable to the earlier years of service. For the most part the public
pension plans with variable rates were found to meet the ERISA
accrual requirements. In fact, many such plans provide for larger
rates of benefit accrual for the earlier years of service and lower rates
of accrual for the later years. However, a small minority of plans were
found to have back-loaded variable-rate formulas which would not be
permitted under ERISA.
The fourth major public pension benefit formula is of the "inte-
grated with Social Security" type as shown in Table E3. Approxi-
mately 16 percent of the state and local plans and 17 percent of the
federal plans utilize a pension benefit formula which takes into ac-
count the benefits provided to employees under the federal OASDI
program in an explicit manner. Some of the plans having formula
types that were previously discussed may also coordinate their benefit
levels with Social Security in an implicit manner by taking into ac-
count Social Security benefit levels in establishing an overall income
replacement goal. It was found that locally-administered plans were
Jour times as likely as state-administered plans to be integrated with
Social Security.
Two basic approaches to Social Security integration were found to
exist among public employee retirement systems. Approximately one-
half of the integrated plans utilize the so-called "offset" approach.
This approach was most frequenthr found among police and fire plans.
The plans covering other categories of employees were more likely to
utilize the "step-rate" approach to Social Security integration.
The pension benefits under plans using the offset approach are
usually calculated as under the flat-benefit and unit-benefit formula
approaches with the exception that the PERS pension benefit is
reduced by a percentage of the participant's Social Security benefit.
The percentage of Social Security offset is usually 50 percent after
30 or 35 years of service which is prorated for persons having fewer
years of service at retirement. Significantly, only four large locally
administered public employee retirement systems (i.e. those having
1,000 or more active members) were found to utilize an offset approach
to integration. The remainder of the plans using this approach were
smaller plans covering local government employees (mainly police
and firefighters).
In contrast to the offset approach, both state-administered as well
as locally administered plans were found to utilize the step-rate
approach to Social Security integration. Generally, public pension
plans of the step-rate type apply a higher benefit accrual rate to
compensation above the "integration level" and a lower rate to
compensation below the integration level. The integration level in
nearly all public plans was $9,000 or less. The integration levels most
commonly used are the former Social Security maximum taxable
wage bases of $4,200, $4,800, $6,600, and $7,800. The accrual rates
applied to compensation below the integration level ranged from .75
percent to 2 percent for each year of service. The accrual rates applied
compensation above the integration level ranged from 1.5 percent to
2.5 percent for each year of service. In most cases the difference
112
between the accrual rates above and below the integration level
amounted to .5 percent or .75 percent.
Generally it can be said that public pension plans presently meet
the Social Security integration rules spelled out by the Internal
Revenue Service in Revenue Ruling 71-446. As applicable to the
formulas used by public pension plans, this IRS Revenue Ruling
generally prohibits offset plans from using a Social Security offset
greater than 83/3 percent and prohibits the differential in the accrual
rates above and below the integration level in step-rate plans from
exceeding 1 percent. The basic purpose of the integration rules is to
ensure that the combined benefits from Social Security and the
pension plan do not provide higher benefits as a percentage of com-
pensation for the more highly paid employees than for the lower
paid employees (thus preventing; discrimination in favor of highly
paid employees, which is prohibited under section 401(a)(4) of the
Internal Revenue Code). The following sections show that the fairly
modest levels of integration found in most public pension plans
generally result in higher combined benefits (as a percentage of
compensation) for the lower paid employees than for the more highly
paid employees.
The compensation used in computing pension benefits is as impor-
tant a determinant of relative pension benefit levels as is the basic
benefit formula itself. For example, if compensation is assumed to
increase 5 percent each year during the 10 years before retirement,
and 4 percent for each year prior to the 10th year, then a person retir-
ing with 40 years of service under a 2.5 percent per year of service
single-rate unit-benefit plan would receive the following benefit,
computed as a percentage of compensation — 100 percent, if compensa-
tion is the final year's; 95 percent, if compensation is a final three
year average: 91 percent, if compensation is a final five year average;
81 percent, if compensation is a final 10-year average; and 48 percent,
if compensation is a 40 year career average. The compensation base
used in public pension plans for benefit computation purposes was
found to range over this entire spectrum.
Typically, in police and fire plans, the compensation used for
benefit computation purposes is the last day's rate of pay or, if actual
compensation is not used, the rate of pay applicable to a particular
rank or grade. Nearly 33 percent of the police and fire plans use the
final day's rate or final year's pay for computing pension benefits. A
5-year average compensation base is utilized in nearly 23 percent of
the police and fire plans with the remainder of the plans using between
a 2- and 10-year average.
Unlike police and fire plans, only 5.2 percent of the state and local
teacher plans use a compensation base of 1 year or less for benefit
computation purposes. Approximately 37 percent of the teacher plans
use a 3-year average, and another 37 percent use a 5-year average
compensation base. Slightly over 9 percent of the teacher plans
calculate pension benefits on a career-average unit-benefit basis.
The most typical provisions found among the plans covering other
categories of state and local government employees were the 5-year
average (44 percent of the plans) and three year average (27 percent
of the plans) compensation bases. The last day rate of pay, final year,
and career average compensation forms were also utilized by such
113
plans. In only a few cases were benefits computed on a basis using
other than actual compensation. For example, only one plan was
found to be of the unit-benefit form which is typically found among
negotiated private pension plans (e.g. where monthly benefits are
computed as a dollar amount, say $5, times years of service).
The federal plans generally follow the pattern of state and local
plans in that the uniformed services compute benefits on the last
day's rate of pay, and the plans covering other categories of employees
generally utilize either a 3-year or 5-year average compensation base
for benefit computation purposes.
Other forms of compensation which are usually added to base pay
for benefit computation purposes are also shown in Table E3. In over
one-fourth of the plans overtime pay is included. Chapter C discusses
some of the inequities and other problems that have arisen in plans
with such provisions. Sick pay, unused sick leave, and longevity pay
are other forms of compensation that are included in the compensation
base in many public employee retirement systems.
The next section shows the effect that the various benefit formulas
and compensation bases discussed above have on the pension benefit
levels applicable to public employees retiring in 1976.
114
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GROSS INCOME REPLACEMENT RATES
The previous sections discussed the wide variations that exist among
public employee retirement system benefit formulas and other plan
provisions. If the benefit levels generated by the differing retirement
plan features are to be compared, an appropriate measure common
to all plans must be developed. The measure utilized in this study to
achieve this goal is called the retirement income replacement rate.
For purposes of this study, the retirement income replacement rate
for an employee retiring as of January 1, 1976 is defined as the percent-
age of the employee's final year preretirement income (1975) which
is replaced by the annual public pension benefit paid to the employee in
1976. The amount of the annual pension benefit was obtained from
each plan in the study for 20 different retirement situations. The study
asked for the pension benefits for employees retiring with 10, 20,
25, 30, and 40 years of service. The final vear earnings levels included
in the study were $6,000, $8,400, $13,200, and $18,000. For purposes
of the study, it was assumed that 25 percent of the employees retired
with earnings of $8,400 or less, 25 percent with earnings between
$8,400 and $13,200, 25 percent with earnings between $13,200 and
$18,000, and 25 percent with earnings over $18,000. Earnings were
assumed to increase at 5 percent for each of the 10 years prior to re-
tirement and at 4 percent for each year prior to the 10th year. For
statistical purposes the replacement rates were weighted by the num-
ber of active employees in the applicable employee coverage category
for each plan (see Tables 42-46 in Appendix I).
Table E4 shows the distribution of relative benefit levels (replace-
ment rates) for all state and local government employees retiring as
of January 1, 1976 with 30 years of service and having 1975 pre-
retirement gross earnings of $13,200 (i.e. the median earnings level).
As might be anticipated, the diversity in the benefit formulas and
other plan features among state and local plans results in a wide
range of replacement rates for retired public employees.
It can be seen in this retirement situation that nearly two-thirds of
the public employees retire with pensions large enough to replace 40
percent to 60 percent of pre-retirement earnings. Because of the
greater diversity in the benefit structures of local government plans,
the persons retiring with benefits either less than 40 percent or greater
than 60 percent of pre-retirement earnings generally tend to be local
government employees. An exception to this general rule is that state
employees not covered by Social Security are more likely to have
replacement rates in excess of 60 percent than are local government
employees in the same category.
As might be expected, the employees not having Social Security
coverage are more likely to have higher PERS income replacement
rates than are the employees who also qualify for a second pension
from Social Security. Thus, 80 percent of the employees without
Social Security coverage have income replacement rates exceeding 50
percent, while only 42 percent of the employees with Social Security
coverage have PERS pensions exceeding this level. It might also bo
observed that a relatively large percentage (75 percent) of the em-
ployees covered by plans which are integrated with Social Security
retire with income replacement rates exceeding 50 percent, while only
116
33 percent of the employees in non-integrated plans retire with pen-
sions exceeding the 50 percent replacement level. The probable rea-
sons for the higher income replacement rates in integrated plans is
discussed below.
TABLE E4.— DISTRIBUTION OF EMPLOYEES BY LEVEL OF INCOME REPLACEMENT RATE i
[In percent of employees]
20
percent 21 to 30 31 to 40 41 to 50 51 to 60 61 to 70 71 to 80
81 to 90
State and local government employees
or less
percent
percent
percent
percent
percent
percent
percent
Total
Employees covered by social security
and by an integrated public pension
plan (approximately 15 percent of
the total employees) _
.2
1.7
10.2
13.2
34.3
30.9
9.1
.4
100
Employees covered by social security
and by a nonintegrated public pen-
sion plan (approximately 55 percent
of the total employees)
1.2
5.6
19.7
40.6
25.2
6.5
1.3
100
Employees covered by a public pen-
sion plan, but not by social security
(approximately 30 percent of the
total employees)... ._
.1
.3
.6
18.5
54.3
7.1
18.5
.6
100
Total employees
.7
3.4
12.5
29.8
35.4
10.3
7.7
.2
100
1 The income replacement rate (shown as a percentage) is defined as the ratio of the annual public pension benefit
received during 1976 for a person retiring on Jan. 1, 1976, with 30 years of service to the final year's wages for such per-
son (in this case $13,200 in 1975).
Using the average income replacement rates shown in Table E5,
some general observations can be made regarding the relative benefit
levels by plan type, employee category, and level of government.
Consistent with an earlier finding, the average income replacement
rate for employees not covered by Social Security (58 percent) is
larger than that for employees with Social Security coverage-46
percent for employees in non-integrated plans and 56 percent for
employees in plans which are explicitly integrated with Social Security.
Surprisingly, the average income replacement rate for integrated
plans exceeds the income replacement rate for non-integrated plans
by 22 percent. Several factors may be responsible for this result. First,
many of the integrated plans of the step-rate form were shown in the
previous section to have integration levels tied to Social Security wage
bases in effect 5, 10, or even 20 years earlier. If the integration levels
set many years earlier are not kept up to date with wage increases, the
income replacement rates will tend to rise over time. For example, if
in 1965 the benefits of an integrated plan were designed to provide an
income replacement ratio of 45 percent to a person retiring with $4,800
of earnings, within 10 years the replacement ratio would have risen
to 51 percent for a person with equivalent earnings of $7,800 (assuming
wage increases of 5 percent per annum and no change in the $4,800
integration level). A second possible reason for the higher replacement
rates in the integrated plans vs. the non-integrated plans could be
that such plans already had relatively high benefit levels which were
modified only slightly on account of plan integration.
As shown in Table E5, the average income replacement rates vary
considerably by employee coverage category. The rates range from 34
percent, which is the average income replacement rate applicable to
employees working in the military commissaries and post exchanges,
to 100 percent or full income replacement for federal judges. The
average income replacement rate of 54 percent for the federal civil
service employees (who are not covered under Social Security), is
117
slightly lower than the average rate of 58 percent for the employees
of state and local governments who are not covered under Social
Security. The average income replacement rate for state government
employees not covered under Social Security is significantly higher
(73 percent) than for all other categories of state and local government
employees.
The average income replacement ratio for locally-administered plans
(58 percent) is significantly higher than the rate for state-administered
plans (50 percent). For each local government employee category —
police and fire, teachers, and general — it can be seen that the average
income replacement ratios are larger when such employees are covered
under locally-administered plans than when covered under state-
administered plans. In this regard the greatest differential (11 percent)
exists for the plans covering general local government employees
(i.e. the average replacement rate is 59 percent for locally-administered
plans and 48 percent for state-administered plans covering local
government employees).
TABLE E5— AVERAGE INCOME REPLACEMENT RATES BY EMPLOYEE CATEGORY, PLAN TYPE, AND SOCIAL SECURITY
STATUS i
Employees covered by
social security Employees
not covered
Plan not Plan by social Total
Level of government and employee category integrated integrated security employees
U Federal systems:
Civil service 54 54
Military . 75 75
Nonappropriated fund.. 32 40 34
Judges 100 100
Legislators 71 71
Other 46 40 54 45
J I. State-administered systems:
State government 48 48 73 49
Local government - 40 55 58 48
Police and fire *i 50... 55 53
Teachers 47 44 56 51
Teachers (higher education) - 42 44 51 43
Judges..... 62 80 65
Legislators. . 63 68 64
Other..... . 43 60 70 51
Total. . 45 55 57 50
111. Locally-administered systems:
Local government ., - 56 60 64 59
Police and fire........ 57 37 61 59
Teachers L 29 67 51 60
Other ....r 41 35 51 41
Total 54 60 61 58
JV. Total State and local systems:
State government 48 48 73 49
Local government ..^ 46 57 62 53
Police and fire 51 37 59 56
Teachers .1 47 57 56 52
Teachers (higher education) 42 44 51 43
Judges... 62 80 65
Legislators — . 63 68 64
Other _s 43 58 68 50
Total 46 56 58 51
100
71
46
40
54
48
48
73
40
55
58
50
55
47
44
56
42
44
51
62
80
63
68
43
60
70
45
55
57
56
60
64
57
37
61
29
67
51
41
35
51
54
60
61
48
48
73
46
57
62
51
37
59
47
57
56
42
44
51
62
80
63
68
43
58
68
46
56
58
1 The income replacement rate (shown as a percentage) is defined as the ratio of the annual public pension benefit
received during 1976 for a person retiring on Jan. 1, 1976, with 30 yrs. of service to the final year's wages for such person
<in this case $13,200 in 1975).
Average income replacement rates within the various employee
coverage categories were also found to vary significantly by geo-
graphic area, by the presence or absence of collective-bargaining,
and by the extent of post-retirement cost-of-living adjustments (see
Table 44-46 in Appendix I). While average income replacement
rates were generally invariant by geographic area for police, fire,
118
and higher education plans, the average replacement rates for all
other employee categories show the following variation in benefit
levels by geographic area — North Central region, 12 percent below
the national average; Southern region, 5 percent below the national
average; Northeast region, 10 percent above the national average;
and the Western region, 13 percent above the national average.
The variation in average replacement rates by the presence or ab-
sence of collective-bargaining is illustrated by the following — little
variation among state employee plans; a 7 percent difference among
teacher, police, and fire plans; and an 18 percent difference among
the plans for other local government employees. The relationship
between initial benefit levels and the form of post-retirement cost-of-
living adjustments is illustrated by the following — the average income
replacement rates are generally higher for employees in plans with
automatic adjustments (usually with a limit) than for employee- in
plans which adjust benefits only periodically on an ad hoc basis
(the differential is 12 percent for state employee plans, 9 percent for
local government employee plans, 7 percent for police and fire plans
and 5 percent for teacher plans).
From Table E6, it can be seen there is a direct correlation between
the relative benefit levels for the plans covering various categories of
employees and the relative funding levels of such plans. At one
extreme the 100 percent income replacement rate for the plans cover-
ing federal judges is contrasted with the completely unfunded nature
of such plans (the ratio of plan assets to total benefit payments is
"0"), while at the other extreme the plans covering state employees
exhibit the lowest average income replacement ratio (49 percent)
and the highest level of funding (the ratio of plan assets to total
benefit payments is 17). At the federal as well as the state and local
level, the plans covering judges, legislators, and uniformed service
employees provide the highest benefits yet exhibit the lowest level of
funding among all plan categories. The one major exception to the
strict ranking of employee categories by decreasing benefit leyels
relates to the Federal Civil Service Retirement System. This system;,
while ranking seventh among the ten categories regarding benefit
levels, also ranks low in regard to the relative level of funding. See
Chapter G for an expanded discussion of funding levels by type of
plan.
TABLE E6.— COMPARISON OF RELATIVE BENEFIT LEVELS AND PLAN FUNDING LEVELS BY EMPLOYEE CATEGORY
Relative
benefit level
and average R^iative
income re- funding level
placement and ratio of
rate after 30 plan assets to
years of total benefit
Benefit level and rank and employee coverage category
service payments
Federal:
1. Judges.. ...
2. Uniformed services
3. Legislators
7. Civil service
100
75
71
54
0
0
5
5
State and local:
4. Judges
5. Legislators
6. Police and fire
8. Local government (general)
9. Teachers..
10. State government (general)
6b
64
56
53
52
49
10
3
11
14
1'
17
119
Up to this point the analysis in this section has been based on the
income replacement rates for a particular retirement situation — an
employee with median earnings of $13,200 retiring with 30 years of
service. Generally, an analysis based on any other retirement situa-
tion would show the same patterns and results. This is the case
because for most plans the income replacement rates remain the same
at the different income levels (for example, at the 30 year of service
level the average income replacement rate for all plans is 51 percent
whether the earnings level is $13,200, $6,000, $8,400, or $18,000).
Also the average income replacement rates exhibit a nearly propor-
tional relationship to years of service (for example, the average income
replacement rates for all plans at the 20, 25, 30, and 40 years service
levels bear the following ratio to the rate at the ten vear service
level— 2, 2.5, 3, 3.9).
Although nearly one-half of the state and local plans appear to
have a minimum benefit provision, the lack of variation in the income
replacement rates among income and service levels would seem to
show that such provisions have little effect on the benefits for persons
retiring with at least ten years of service and with at least $6,000 of
earnings. At the other end of the benefit spectrum, nearly one-half of
the plans also indicate having a maximum benefit provision (for
example, limiting the 3^ears of credited service or, as in the Federal
Civil Service Retirement System, limiting the replacement rate to
80 percent).
When ERISA was passed, an amendment to the Internal Revenue
Code (section 415) was included which places certain limitations on
the benefits paid from and contributions made to private pension
plans. This provision also applies to qualified public employee retire-
ment systems. Generally, the provision most relevant to public pension
plans prohibits a qualified plan from paying an annual pension
(employer-financed) in an amount exceeding 100 percent of the par-
ticipant's average high three consecutive years of compensation. A
number of public pension plans are shown in Table 42 of Appendix I
to currently provide for the payment of benefits exceeding this limit.
NET INCOME REPLACEMENT RATES
In a recent report to the Congress, the Comptroller General of the
United States stated that "there is no standard or method of assessing
the adequacy of Federal employee retirement programs".1 When con-
sidered in the context of retirement income replacement goals, this
statement is as applicable to state and local government and private
pension plans as it is to the federal programs. There is presently no
generally accepted set of conditions defining the level at which retire-
ment income can be considered 1 'adequate". Neither, on the other
hand, is there any broad-based public policy setting forth the limit
beyond which retirement income should be considered "excessive".
In the absence of a generally accepted measure of retirement income
adequacy, a suitable means of charting the continuum of retirement
income levels for employees in different retirement situations is needed.
Oftentimes the concept of net income replacement is used for this
1 U.S. General Accounting Office. "Report to the Congress by the Comptroller General of
the United States : Federal Retirement Systems : Unrecognized Costs, Inadequate Funding,
Inconsistent Benefits" (Washington, D.C : U.S. Government Printing Office, 1977), p. ii.
120
purpose, The net income replacement rate for an individual is defined
as the percentage of pre-retirement net income replaced by the com-
bined retirement benefits (after-tax) to which the individual is en-
titled under various retirement programs (e.g. pension plans, Social
Security, etc.). In this study (see Table E7) pre-retirement net income
is defined as gross pay less (a) federal and state taxes, and (b) employee
Social Security and pension plan contributions, if any.
As discussed in Chapter B, perhaps as many as two million state
and local government employees (approximately one-third of whom
are full-time workers) are not currently covered under a public pension
plan. It is estimated that nearly 80 percent of such employees, how-
ever, are covered under Social Security. Illustrative net income re-
placement rates from primary Social Security benefits alone for
married employees lacking PERS coverage are as follows — 54 percent
of $8,400 final pay, 42 percent of $13,200 final pay, and 32 percent of
$18,000 final pay. The net income replacement rates for single em-
ployees tend to be a few percentage points higher than for married em-
ployees who are otherwise similarly situated. If Social Security spouse
benefits were taken into account, the above net income replacement
rates would be 50 percent larger (assuming the spouse is at least the
same age as the worker). The above illustrations assume retirement
at age 65 (on January 1, 1976) and pre-retirement earnings increases
in accordance with that described in the previous section.
It might be noted that the net income replacement rates decline as
net income increases for the above mentioned employees who are
covered only under Social Security. In contrast, for the employees
covered under a public pension plan and not under Social Security,
the net income replacement rates are significantly higher and remain
nearly level as net income increases. The net income replacement rate
after 30 years of service is 65 percent for a married employee who is
covered under a plan having median-average benefit levels. The re-
placement rate rises to 83 percent for an employee in the same plan
who retires after 40 years of service. As shown in Table E7, full net
income replacement is not achieved until pension benefits equal 89
percent of final year pay. Full net income replacement is rarely
achieved for employees retiring after 30 years of service, although
over 7 percent of the state and local government employees without
Social Security coverage are in plans providing full net income re-
placement after 40 years of service. The Federal Civil Service Retire-
ment System provides 60 percent net income replacement after 30
years of service and maximum net income replacement of 85 percent
after 42 years of service for employees having earnings as shown in
Table E7.
The above net income replacement rates for employees who are
not covered under Social Security are applicable not only at age 65
but also at any earlier normal retirement age at which the employees
may retire. The net income replacement rates are understated for
some of the above employees who become eligible for Social Security
benefits through part-time private employment or through private
employment occurring before or after periods of public service
enmloyment.
If the Social Security benefits for such employees were taken into
account, the net income replacement rates would be increased by at
121
least 18 percent, 12 percent, and 9 percent for employees having final
year earnings in 1975 of $8,400, $13,200, and $18,000, respectively.
While the increases may be larger for employees having more than
minimal earnings under Social Securit}^ the smallest increments as
shown above apply to those persons attaining age 65 in 1975-76 who
were eligible for the minimum Social Security benefit of $101.40 per
month. While approximately 30 percent of the state and local govern-
ment employees in public pension plans do not contribute to Social
Security, the incidence among career public employees of dual Social
Security entitlements through non-public service employment is
unknown. A 1969 study of federal civil service retirees showed approxi-
mately 43 percent also receiving Social Security benefits (the incidence
among career employees, for example those having 30 or more years
of service, may be different from the aggregate percentage).2
The retirement income levels applicable to public employees having
both PERS and Social Security coverage are quite different than the
levels for the two groups of employees discussed above. Table E7 (line
12) shows the PERS pension expressed as a percentage of final year pay
which is required to replace 100 percent of pre-retirement net income.
For married employees retiring with final year earnings of $8,400,
$13,200, and $18,000, pre-retirement net income is replaced when the
PERS pension reaches 33.1 percent, 42.5 percent, and 53.5 percent of
final pay, respectively. For employees in contributory plans which pro-
vide median-average benefit levels, it can be seen that full net income
replacement occurs after 20 to 25 years of service at earnings levels
below the median and after 30 to 40 years of service at earnings levels
above the median. Emplo3^ees in plans providing pensions at levels
identical or similar to the levels under the Military Retirement
System are shown to obtain full net income replacement after 20 or
25 years of service.
2 U.S. Congress, Committee on Ways and Means, "Background Material on Social Security
Coverage of Government Employees and Employees of Nonprofit Organizations," Ways and
Means Committee print 94-127, 94th Cong., 2d sess. (Washington, D.C : U.S. Government
Printing Office, 1976).
122
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123
It should be noted that the analysis in the preceding paragraph
assumes that retirement occurs at age 65 and that PERS and Social
Security benefits commence at that time. However, the net income
replacement rates based on PERS benefits alone remain unchanged
if retirement occurs at a normal retirement age earlier than age 65. On
the other hand, the net income replacement rates based on Social
Security benefits are reduced for retirements occurring earlier than
age 65. The rates are reduced by 6% percent for each year of early
retirement reaching a maximum of 20 percent for retirement at age
62. Instead of drawing a reduced Social Security benefit, however,
a public employee retiring at age 62 with a PERS pension can defer
drawing Social Security benefits until age 65. As discussed previously,
some public pension plans permit retirement even earlier than age
62, some as early as age 50 or 55. An employee retiring with a PERS
pension at, for example, age 55 must wait until at least 62 to begin
drawing Social Security benefits.
Prior to the time Social Security benefits become payable, the
employee's net income replacement level depends solely on the level
of the PERS benefits at retirement and the extent to which such
benefits are adjusted for subsequent cost-of-living increases. When
Social Security benefits become payable, however, the retired employ-
ee's income increases dramatically in absolute terms. For example,
in the case of an employee who retires at age 55 with 1975 pre-retire-
ment earnings of $13,200 (and no earnings thereafter), the Social
Security benefits projected to begin at age 65 represent over 75 per-
cent of the individual's pre-retirement net income. However, the 75
percent level reduces to an equivalent level of 45 percent if projected
cost-of-living increases are also taken into account for the 10 years
between age 55 and the time the retired employee reaches age 65
(note that the equivalent 45 percent net income replacement rate
for the employee retiring at age 55 is the same as the rate shown in
Table E7 for the employee retiring at age 65 with identical pre-retire-
ment earnings).
While Table E7 presents the net income replacement situation for
employees in public pension plans providing median-average benefit
levels, Table E8 shows the wide range over which the net income
replacement rates vary for state and local government employees.
The situation depicted relates to employees retiring at age 65 on
January 1, 1976 after 30 years of service.
The percentage of pre-retirement net income replaced by PERS
pensions in combination with Social Security, when applicable, is
greater than 50 percent for nearly all public employees who retire
with at least 30 years of service. Twenty seven percent of the total
number of career employees in this retirement situation are shown
as having replacement rates in the 50 percent to 75 percent range.
Nearly all of the employees in this category can be seen to lack Social
Security coverage. At the other extreme, twelve percent of the total
number of career employees are shown as having 125 percent or more
of their pre-retirement net income replaced through a combination of
PERS and Social Security benefits. All of the employees in this
category are covered under Social Security, and the vast majority
of them can be seen to have pre-retirement earnings of $13,200 (the
median) or less.
74_365 — 78 9
124
Nearly all of the employees having net income replacement rates
of between 100 percent and 125 percent can also be seen to have Social
Security coverage. Slightly less than one-fourth of the total number
of employees are shown as having net income replacement rates in
the 75 percent to 100 percent range. From the foregoing, it is conserva-
tively estimated that one-half of the career public service employees
(i.e. having 30 or more years of service at retirement) who retire at
age 65 have net income replacement rates of less than 100 percent,
while the remaining employees have net income replacement rates
exceeding 100 percent in their first year after retirement.
125
126
SUMMARY AND CONCLUSIONS
1. PERS Retirement Provisions
Generally, public employee retirement systems meet ERISA's
minimum provisions regarding normal retirement age. Most plans
provide for several optional normal retirement ages requiring short
periods of service at the higher ages (60 to 65) and longer periods of
service at earlier retirement ages (50 or 55). A few plans do, however,
require more than ten years of service at retirement which is gen-
erally prohibited under ERISA.
Because of the fairly liberal normal retirement provisions in the
majority of the public plans, particularly those at the federal and
local government levels, such plans generally do not provide for the
payment of early retirement benefits on an actuarially reduced (or
other) basis. A few large federal, state, and local plans, having 1,000
or more active members, and about 425 smaller plans were found to
have mandatory retirement ages earlier than age 65, some as early as
age 50.
Most public employees are covered under plans providing total and
permanent service-connected and non-service-connected disability
benefits. However, a substantial number of small police and fire and
local government employee plans do not provide such coverage. While
the Military Retirement System and plans covering teachers in higher
education provide partial service-connected and non-service-connected
disability benefits, other PERS plans typically do not offer partial
disability benefits in either case.
About 70 percent of the total number of state and local govern-
ment employees as well as the federal uniformed service employees are
covered under the Social Security disability program. Public employees
may also be covered for disability under workmen's compensation laws.
While about one-half of the state employee and large municipal em-
ployee pension plans reduce plan provided disability benefits by some
portion of Social Security or workmen's compensation benefits, most
police, fire, and teacher plans do not provide for such reductions.
Over one-third of the state and local government pension plans,
principally local police and fire plans, do not provide post-retirement
joint and survivior annuity options. In plans which do provide such
provisions, rarely is the joint and survivor annuity automatic (unless
waived) as required under ERISA. Pre-retirement death benefits
under public plans are usually provided in the form of the return of
member contributions or annuity payments to the spouse or other
dependents, or sometimes only a lump-sum payment is made.
Over 95 percent of all federal, state, and local government pension
plan participants (small plan participants being the main exception)
are covered under plans making one or more types of post-retirement
cost-of-living adjustments. Over 90 percent of the state and local
government participants are in plans which adjust pension benefits
either automatically (with a limit) or on an ad hoc basis, while
less than 5 percent are in plans providing unlimited post-retirement
cost-of-living adjustments (which is the provision applying to nearly
all the employees in federal plans).
127
2. PERS Benefit Formulas and Amounts
The benefit formulas of public pension plans, while diverse in form
and nature, can generally be classified as being of the flat-rate type
(27 percent), unit-benefit type with either a single or variable rate per
year of service (52 percent), or of the 1 'integrated" with Social
Security type (16 percent). A small minority of plans were found to
have "back-loaded" formulas which would not meet the ERISA
benefit-accrual requirements. Generally, public pension plans were
found to meet the Internal Revenue Service requirement which limits
the degree to which the pension benefits under a qualified public or
private pension plan may be "integrated" with Social Security benefits.
Most plans base benefits on final average compensation, 36 percent
of such plans use a final 5-year average and 33 percent use an average
of the final 3 years or less, although 24 percent of such plans base
benefits on the rate of pay on the last day before retirement (prin-
cipally police and fire plans).
The wide variations in benefit levels that exist among public em-
ployee retirement systems is brought into focus when the distribution
of gross income replacement rates are plotted for all public plans. The
gross income replacement rate for an individual is the amount of the
pension benefit in the first year of retirement expressed as a percentage
of pre-retirement base earnings. Benefits expressed as a percentage of
pre-retirement gross earnings generally ranged from 20 percent to
80 percent, and the majority of the career employees (having 30 years
of service at retirement) were found to retire with PERS benefits
replacing 40 percent to 60 percent of pre-retirement earnings.
Using the average gross income replacement rate of 51 percent for
all state and local government employees (with 30 years of service)
as a comparator, higher than average rates were found to apply to
employees not covered by Social Security as well as to employees
covered under both Social Security and a PERS plan "integrated"
with Social Security. Generally, the highest average income replace-
ment rates were found in plans covering judges, legislators, the
military, and local policemen and firemen. Locally-administered plans
had significantly higher rates than state-administered plans.
Average income replacement rates were also found to vary signifi-
cantly by geographic region with the North Central and Southern
regions having rates below the national average and the Northeastern
and Western regions having rates above the national average. A
positive correlation was found to exist between higher than average
income replacement rates and the degree of plan underfunding, the
presence of automatic cost-of living adjustments, and the presence of
collective-bargaining at the local government level.
Generally, there is an absence of a broad-based public policy defining
the criteria on which to judge the adequacy of retirement income. In
the absence of a generally accepted measure of retirement income
adequacy, this study utilized the concept of the net income replace-
ment rate to show the continuum of retirement income levels for
public employees covered under public pension plans and, when
applicable, Social Security.
128
Public employees (including the military) who are covered by Social
Security and a PERS plan with average benefits are shown to attain
full net income replacement from combined PERS and Social Security
benefits after 20 or 25 years of service (at earnings levels below the
median) and after 30 or 40 years of service (at earnings levels above
the median). In contrast, the public employees who are not covered
under Social Security achieve an average net income replacement of
50 percent to 60 percent after 30 years of service and rarely achieve
full net income replacement based on PERS benefits alone.
Chapter F — PERS Finances
The public employee retirement system (PERS) has a vast in-
fluence on the national economy. The $108.3 billion in assets held
by state and local government funds are nearly half as large as the
total funds held by private sector pension plans. Together the public
and private pension funds constitute the largest single source of
investment capital in the United States. The annual benefit pay-
ments made by state and local systems add over $7 billion, and the
federal systems over $14 billion, to the consumption and savings
elements of the economy. Every year nearly $6 billion of the invest-
ment earnings of state and local funds are excluded from federal
taxation. In 1975, federal, state, and local taxpayers supported
governmental employer pension contributions in the order of $23
billion.
ASSETS AND INCOME
In 1975, the total book value of the assets of state and local govern-
ment pension systems amounted to $108.3 billion while the assets
of all federal systems totaled $40.4 billion. The asset and other
financial values shown in Table Fl do not reflect the finances of the
''closed group" and 1 'supplemental" plans excluded from the Pension
Task Force Survey (see chapter B). The figures in Table Fl are under-
stated less than 1 percent because of the excluded plans.
The assets of state and local pension systems have been increasing
at a rate of about 13 percent per annum in recent years. The public
pension system assets are now 51 percent as large as the total assets
of all private sector pension plans (see Table Gl2). This percentage
is somewhat striking given the fact that the total number of public
pension plan participants is only 33 percent as large as the total number
of private pension plan participants. On the other hand, it should be
noted that the average benefit payment to those currently receiving
benefits under public pension plans is over 70 percent greater than
the average benefit pa3Tnent made under private pension plans. A
discussion of public and private pension plan assets and benefit
payments as they relate to the funding progress of the PERS versus the
private pension system is given in Chapter G.
The distribution of the total assets held by state and local plans by
size of system and level of administration is shown in Table Fl.
The largest plans, i.e. the 7 percent having 1,000 or more active
participants, hold 95 percent of the total assets of all state and local
plans while the smaller plans hold the remaining 5 percent. Public
pension plans administered at the state level hold about 76 percent
of the total funds as compared with the locally administered plans
which account for 24 percent of the total. The large state administered
plans covering the two categories — teachers, and state employees
(including some consolidated plans covering local government
employees) — control two-thirds of the total state and local government
pension funds.
(129)
130
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131
Public pension plans generally used one of several methods to arrive
at the book value of assets shown in Table Fl. The majority of all plans
valued their assets at original cost. Less than one-quarter of the plans
valued some or all plan assets on a market basis. About 13 percent of
all plans (mainly small plans) holding less than 1 percent of total
assets used market value as the exclusive basis on which to determine
book value. Many plans, the large plans in particular, were found to
carry the value of fixed income securities on an amortized (or depreci-
ated) cost basis. It was also found that most plans use the "book
value" of plan assets for actuarial valuation purposes. Thus, all but
a small minority of plans ignore unrealized investment gains and
losses in their actuarial valuations and contribution determinations.
Detailed information on the asset valuation methods used by public
plans is given in Tables 50, 51, and 59 of Appendix I.
In addition to the book value of plan assets, the Pension Task
Force Survey questionnaire asked for the value of plan assets at
market and at cost. Over 70 percent of all public plans and over 60
percent of the federal and large state and local plans do not compute
the market value of plan assets and were unable to supply such
information. For those plans which were able to supply the market
value of plan assets, the ratio of the total market value to the total
book value of the assets for all such plans was found to be 90 percent
(the corresponding ratio for private pension trust funds was 100
percent in 1975). The distribution of the market/book value ratio for
public plans was found to be less than 80 percent for 6 percent of the
plans, between 80 percent and 89 percent for 11.4 percent of the plans,
between 90 percent and 99 percent for 28 percent of the plans, and
between 100 percent and 104 percent for 54.3 of the plans. Because the
book value of plan assets for most public plans is computed on a cost
basis, the ratio of plan assets valued at cost to their total book value
averaged 99 percent.
It can be seen (column (5) of Table Fl) that the assets of the federal
plans generated income of $2.2 billion and that the assets of the state
and local plans generated $5.9 billion of investment income for fiscal
plan years ending in 1975. For the public plans administered at both
the state and local level, the total investment income amounted to
27-28 percent of total plan revenues. This percentage is greater than
the corresponding percentage of 12 percent for federal plans and the
estimated percentage of 20 percent for all private sector pension plans.
It can also be seen (Table Fl column (11)) that the ratio of plan
investment income to plan assets shows a remarkable stability across
-all categories of federal, state, and local pensions plans. While the
actual rates of investment return for different public plans varies over
a broad range, the ratio of 5.4-5.5 shown for federal, state and locally
administered plans is indicative of the fact that many plans experi-
enced book value rates of investment return in the 5 percent to 6
percent range for fiscal years ending in 1975.
The similarity in the overall rates of return for state administered
and locally administered pension plans is perhaps derived in large
part from the similarity in the investment mix of the plans in the
two categories as shown in Table F2. About 22 percent of the public
132
pension funds at the state level as well as the local level are invested
in corporate stock. This percentage is considerably lower than the
approximately 58 percent of all private pension trust funds which are
invested in corporate common and preferred stock (preferred stock
being less than 1 percent of the total).
The lower percentage of common stock investment by public
pension plans is probably a reflection of the statutory provisions
which continue to restrict such investments. Based on a joint Pension
Task Force — University of Pennsylvania Pension Research Council
investment survey, only 7 percent of the state and local funds re-
sponding were found to be completely free of restrictions regarding
investment in common stock. Slightly less than 10 percent of the
state and local plans were found to be totally prohibited from investing
in common stock. In about 60 percent of the plans common stock
investment was limited to 35 percent of plan assets or less, and common
stock investment in over 80 percent of plans was limited to 50 percent
of total plan assets or less. However, as shown in Table F2, public
pension fund investment in corporate stock took a dramatic jump from
3 percent in 1961-62 to 22 percent in 1975-76 as the restrictions on such
investments were eased in this period.
As shown in Table F2, the percentage of state and local pension
funds invested in corporate bonds rose from about 41 percent in
1961-2 to about 52 percent in 1975-76. The corresponding percentage
at the end of 1975 for private pension trust funds was 26 percent.
Because the percentage investment in corporate bonds for public
plans is about double that for private plans (which hold assets double
those of public plans), the public and private pension systems both
invest an approximately equal dollar amount in corporate bonds.
The percentage level of investment in corporate bonds vis-a-vis cor-
porate stock take on nearly equal but opposite roles in the public
pension system versus the private pension system.
As shown in Table F2, cash and deposits plus federal securities
make up just under 10 percent of the total investments of state and
local pension funds for fiscal years ending in 1975-76 (an identical
percentage of private pension trust funds were similarly invested in
1975). The 8.3 percent of total state and local pension funds invested
in federal securities in 1975 represents a dramatic shift in investment
policy from the 1961-62 period when over 26 percent of public pension
funds were invested in federal securities.
Investment in mortgages, amounting to roughly $8 billion in 1975
or about 7.3 percent of the total assets of public pension funds, plays
a minor but much more important investment role among public
pension funds than among private pension trust funds which had
only 1.6 percent of their assets invested in mortgages during 1975.
The category shown as 1 'other securities" in Table F2 consists mostly
of foreign bonds, commercial paper, loans to members, and other
direct loans. Direct investment in real estate by public pension
funds is relatively unimportant and makes up but a small part of the
1.3 percent of total public pension fund assets shown in Table F2 as
"all other investments".
133
TABLE F2.— PERCENTAGE OF STATE AND LOCAL RETIREMENT SYSTEM ASSETS BY INVESTMENT CATEGORY
State
and
local
gov-
Cash Fed- em* All
System category and fiscal
year ending in —
and
de-
posits
/i \
(l)
eral
secu-
rities
ment
secu-
rities
(3)
Corpo-
rate
bonds
(4)
Corpo-
rate
stocks
(5)
Mort-
gages
(o)
Other other
secu- invest-
rities ments
(7) (8)
1 otai
1. State administered:
26. 7
11. 1
43. 1
3. 3
12. 2
2 7
i fin
luU
1971-72.
. 8
4. 4
1. 3
57. 8
18. 0
12. 0
0)
5." 7
i nn
1UU
1972-73.
1. 0
3. 7
. 6
57. 9
20. 6
10. 2
(O
6.0
100
1973-74...
1. 1
5. 6
. 5
55. 9
22. 2
8. 7
5.2
.8
100
1374-75.
1. 1
6. 5
. 3
55. 8
22. 0
8. 7
5.3
.3
100
1975-76
7
8. 4
1. 4
52. 5
22. 1
8. 4
5.2
1.1
100
II. Locailv administered:
1961-62
1.7
25.3
30.0
36.4
2.3
2.1
0)
2.0
100
1971- 72.
1972- 73.
2.1
2.7
8.4
6.5
9.9
6.0
47.4
47.4
19.3
25.1
4.9
4.3
(O
0)
7.9
8.0
100
100
1973-74..
3.6
7.6
2.4
51.4
22.9
3.9
6.2
1.9
100
1974-75 ....
5.2
7.1
2.2
51.0
22.8
3.5
6.2
1.8
100
1975-76
2.7
7.7
7.5
48.1
21.9
2.6
7.5
1.9
100
II. Total State and local:
1951-62
1.2
25.2
17.4
40.9
3.0
8.8
(0
2.4
100
1971-72....
1.1
5.4
3.5
55.1
18.3
10.2
0)
6.2
100
1972-73
1.4
4.4
1.9
55.3
21.7
8.7
0)
6.5
100
1973-74...
. 1.7
6.0
.9
54.8
22.3
7.6
5.4
1.1
100
1974-75
2.0
6.7
.7
54.6
22.2
7.5
5.5
.7
100
1975-76.
1.3
8.3
2.8
51.5
22.1
7.1
5.7
1.3
100
!The categories "Other securities" and "All other investments," were combined for the years 1961-62, 1971-72,
and 1S72-73.
Source: U.S. Bureau of the Census.
A dramatic shift in the investment policies of public pension funds
took place over the 20 year period ending in 1974-75. During this
period public pension fund investment in state and local government
securities dropped from over 25 percent to less than 1 percent of the
total invested assets of such funds.
However, the decline in the investment of state and local govern-
ment securities ended abruptly in 1975-76 as shown in Table F2.
Within one year the percentage of total public pension funds invested
in state and ]ocal government securities jumped from 2.2 percent to
7.5 percent for locally administered funds and from .7 percent to 1.4
percent for state administered funds. Further investigation revealed
that this investment policy turnabout is being carried forward into
periods subsequent to the last one shown in Table F2.
While the percentage of total public pension fund assets invested in
state and local government securities remains relatively small, it can
be seen (Table F3) that such investments are concentrated in the
plans of a few states. The state-administered plans in 28 states and the
locally-administered plans in 17 states are shown as having no state
and local government security investments. On the other hand, such
investments exceed 5 percent of total assets for the locally-adminis-
tered plans in six states and for the state-administered plans in one
state. In the locally-administered plans of three of these states —
Montana, New York, and New Jersey — a definite break with past
policy (wherein the total investment in state and local government
securities diminished as in the other states) appears to have taken place.
134
Between the fiscal years 1974-75 and 1975-76 the percentage of
plan assets invested in state and local government securities jumped
from 0 percent to 36 percent for the Jersey City, New Jersey plan,
from 4.6 percent to 19.7 percent for six New York City plans, from
.7 percent to 8.9 percent for two New York State plans, and from 9.1
percent to 12.2 percent for the locally-administered plans in Montana.
Because of the magnitude of the New York plans which hold over
15 percent of the assets of all state-administered plans and over 35
percent of the assets of all locally-administered plans, any major shift
in the investment policy of such plans is immediately evident in the
aggregate statistics of the PERS as shown in Table F2.
TABLE F3.- PERCENTAGE OF PUBLIC EMPLOYEE RETIREMENT SYSTEM ASSETS HELD IN STATE AND LOCAL
GOVERNMENT SECURITIES (FISCAL YEARS ENDING IN 1975-76)
State- Locally
administered administered
State plans plans Total
Alabama r.4 0
Alaska...
Arizona.
Arkansas
.1
0
.1
California
.2
.2
.2
Colorado
.2
0
Connecticut
.2
0
Delaware
District of Columbia . _ . .
Florida
0
.2
0
1.3
.1
Hawaii
.1 — .
.1
Illinois
0
1.6
.6
1.2
0
1.2
.2
1. 6
.7
1.5
.2
1.6
.3
.7
.2
.7
.2
0
0
.5
.3
.1
.3
.1
.6
.1
.5
6.1
0
0
0
.4
12.2
.7
.3
.2
0
14.6
.1
8.9
19.7
13.6
.8
.3
.8
5.2
.4
.1
.9
.3
o'
.1
.1
.1
0
1.0
.1
.2 ....
.2
1.3 — .
1.3
.8
0
0
1.0
6.1
2.7
.1
.1
.1
.1
1.4
7.5
2.8
Source: U.S. Bureau of the Census.
135
The investment-policies of the federal government pension plans
stand in marked contrast to the above described investment policies
of state and local government pension plans. The several contributory
plans covering federal civilian employees generally limit investments
to interest-bearing securities of the United States or to other obliga-
tions guaranteed as to both principal and interest by the United States
government. On the other hand, the following federally-related pension
plans generally follow investment policies and practices typical of
those found among private sector pension plans which in several
cases includes the use of insurance companies as the medium for
pension fund investments — Farm Credit District Ketirement Plans;
Federal Reserve Board/Bank Employees Retirement Systems; Federal
Home Loan Bank Retirement Systems; Federal Home Loan Mortgage
Corporation Retirement Plan; Tennessee Valley Authority Retire-
ment System; TIAA-CREF plans for Faculty of the Uniformed
Services University of the Health Sciences, for Private Role Employees
of the Smithsonian Institution, and for the Graduate School of the
U.S. Department of Agriculture; and the several Nonappropriated
Fund Employees Retirement Plans. (See Table VI of Appendix IV
for a listing of financial and other statistics for the 68 federal retire-
ment systems).
EMPLOYEE AND EMPLOYER CONTRIBUTIONS AND BENEFIT PAYMENTS
Public employees and employers contributed nearly $15.5 billion
to state and local retirement systems during plan fiscal years ending
in 1975. A near identical amount, $15.7 billion, was contributed to the
68 federal retirement systems. Employee contributions play a much
more important revenue role in the public employee retirement system
than in the private pension system. Employee contributions make up
35 percent of the contributions to state and local pension plans and
16 percent of the federal plan contributions in contrast to the employee
contributions to private plans, which total less than 8 percent.
As mentioned in Chapter B, there appears to be a growing trend to
eliminate mandatory employee contribution requirements from public
pension plans. Contributions for at least some employees have now
been eliminated in over 30 percent of all public pension plans so that
nearly 15 percent of all state and local government employees no
longer contribute to their plans. Members of the federal uniformed
services account for nearly the entire 57 percent of the federal workforce
not required to make pension contributions. Thus, 100 percent of the
contributions to the above plans can be classified as "employer con-
tributions". In contrast only 1.2 percent of all public plans covering
fewer than 1 percent of all participants (mainly volunteer firemen and
university faculty) derive their contribution income solely from
voluntary employee contributions.
The remaining plans, covering 85 percent of all state and local
government employees, derive approximately 40 percent of their
total contribution income from mandatory employee contributions.
However the relative importance of employer contributions to total
contribution income varies greatly from plan to plan. For example,
the ratio of employee to employer contributions was found to be
136
distributed in the following manner for the large defined benefit plans
which account for over 90 percent of the assets, revenues, and ex-
penses of all state and local plans. In about 13 percent of such plans
employee contributions as a percentage of employer contributions
were found to be less than 25 percent; the percentage was between
25 and 50 percent in 21 percent of the plans, between 50 and 75 percent
in 33 percent of the plans, and between 75 and 100 percent in 19 per-
cent of the plans. Employee contributions exceeded employer con-
tributions in 13 percent of the plans.
As shown in Table Fl, column (8), there is also some variation in the
overall ratio of employee to employer contributions with regard to the
different categories of federal, state, and local pension plans. The varia-
tion between the larger and smaller state and local systems derives
partly from the fact that employees in smaller plans have lower con-
tribution rates than employees in the larger plans. For example, em-
ployees in over 65 percent of the smaller plans contribute less than 6
percent of pay while the employees in only 42 percent of the larger plans
contribute less than this amount. The difference in the ratio of em-
ployee to employer contributions between state-administered plans (58
percent) and locally-administered plans (41 percent) is largely ex-
plained by the much smaller ratio for the New York City plans (17
percent) which account for over 35 percent of the total finances of
locally-administered plans. When the effect of the New York City
plans is removed, the ratio for the locally-administered plans is 56
percent or more nearly equal to the ratio for the state-administered
plans.
Total employee and employer contributions expressed as a per-
centage of payroll is shown in Table F4 to vary widely from plan to
plan. For the larger state and local defined benefit pension plans the
total employer and employee contributions as a percentage of payroll
averages about 16 percent. The average payroll contribution for
smaller defined benefit plans is somewhat larger — 18 percent. The
average payroll contributions to defined contribution plans is 2 percent
to 5 percent less than for defined benefit plans depending on which plan
size category is compared.
Total contributions as a percentage of payroll for state and local
pension plans differ sharply from the payroll contributions for both
federal plans and private pension plans. While the contributions for
about 26 percent of the large state and local plans amount to 10 per-
cent of payroll or less, approximately 85 percent of all large corporate
employers make pension contributions of 10 percent or less.1 The
average corporate pension contribution of slightly over 6 percent of
payroll is less than 40 percent of the comparable percentage (16 per-
cent) for large state and local plans. In contrast to both state and local
as well as private pension plans, the total employee and employer con-
tributions to the Federal Civil Service Retirement System and to the
Military Retirement System amount to nearly 26 percent of payroll
and 40 percent of payroll, respectively. Currently less than 9 percent
of the large state and local plans have contributions equal to or greater
than the federal contribution levels.
1 Chamber of Commerce of the United States of America Employee Benefits, 1975 (Washington, D.C,.
Chamber of Commerce of the United States of America: 1976).
137
The differences among the contribution levels of federal, state and
local, and private pension plans are closely correlated with the dif-
ferences among the current benefit payment levels of such plans. For
the large state and local pension plans shown in Table F4, the average
annual benefit payout as a percentage of payroll is 7.9 percent. In
contrast the average payout for all private pension plans is approxi-
mately 3 percent, or somewhat less than 40 percent of the state and
local plan payout rate. Just as with the contribution levels, the bene-
fit payout levels of the federal pension plans greatly exceed those
of state and local and private pension plans. The total annual bene-
fit payments from the Civil Service Retirement System exceed 20 per-
cent of payroll while the comparable figure for the Military Retirement
System is almost 40 percent. Rates of benefit payout exceeding the
federal plan levels occur in less than 4 percent of the large state and
local government pension plans (although annual benefit payments
exceed 20 percent of payroll in over 20 percent of the smaller state and
local pension plans) .
The observed variation among federal, state and local, and private
pension plans in annual benefit payment levels expressed as a percent-
age of payroll is accounted for by the differences in plan benefit struc-
ture as well as the relative "maturity" of the systems (benefit structure
was discussed in Chapters D and E) . Using the Social Security system
benefit payout level (9.8 percent of taxable payroll in 1975) as a
benchmark, it can be seen from Table F4 that the benefit payout levels
in only 20 percent of the large state and local plans exceed this amount
(probably even fewer private plans exceed the 9.8 percent Social
Security benefit payout level). This relationship should be considered
in light of the more advanced development of the Social Security sys-
tem which pays benefits to 40 persons for every 100 contributing active
participants while the beneficiary to active participant ratio for the
state and local system and the private pension system is 19 percent and
23 percent, respectively. Both major federal pension plans, the Civil
Service Retirement System and the Military Retirement System, pre-
date Social Security and presently have beneficiary to active partici-
pant ratios exceeding 50 percent.
TABLE F4.— DISTRIBUTION OF RETIREMENT SYSTEMS BY LEVEL OF CONTRIBUTIONS AND BENEFIT PAYMENTS
EXPRESSED AS A PERCENTAGE OF PAYROLL
Percent of large State and local definedjbenefit retirement systems
None
to 5
6 to
10
11 to
15
16 to
20
21 to
25
26 to
30
31 to
35
Over
35 Total
Total annual employee and employer
contributions as a percentage of
payroll
Total annual benefit payments as a
percentage of payroll
4.2
22.0
33.1
23.0
9.1
3.5
3.1
2.0 100
49.0
30.8
10.8
5.6
1.4
.3
1.4
.7 100
The various financial ratios shown in Table Fl — involving benefits,
contributions, and total revenues — reveal some general patterns
about public pension financing which are taken up in more detail in
the next chapter on funding. From column (9) of Table Fl it can be
seen that federal pension plan revenues are only 30 percent greater
than the current annual benefit payments from such plans, whereas
138
state arid local pension plan revenues are nearly three times annual
benefit payments. From column (7) it can be seen that for all federal
plans in the aggregate the employer contributions taken alone fall
somewhat short of being sufficient to meet current benefit payments.
The employer contributions for state and local plans exceed total
benefit payments by 40 percent. State-administered plans are shown
to have a higher revenue to benefit payout ratio, 3.2, than locally-
administered plans, 2.4, and thus can be expected to be more ade-
auately financed over the long run. Locally-administered police and
fire plans, shown as having a revenue to benefit ratio of 2.0, can be
expected to encounter the greatest long-term financing problems
among all categories of state and local pension plans.
EMPLOYEE CONTRIBUTION RATES
For the 85 percent of the state and local government employees who
are required to make pension plan contributions, the most common
contribution formula is of the single rate type. The wide variation in
the required rate of employee contributions is shown in Table F5.
The most common employee contribution rate among locally-
administered plans is 5 percent while the most common rate among
state-administered plans is 6 percent. The employees in nearly one-
third of the plans with a single rate contribute less than 5 percent of
pay while the employees in nearly 40 percent of the plans contribute
at a rate of 6 percent or more.
As might be expected, the contribution rates for employees not
covered by Social Security tend to be larger than the rates for those
public employees who are also covered by Social Security. However,
when the 1975 Social Security employee contribution rate of 5.85
percent is taken into account, the combined Social Security and PERS
contribution rates exceed 10 percent in over 65 percent of the plans
where employees are covered by Social Security while the PEES con-
tribution rates exceed 10 percent in only 1 percent of the plans where
employees are not covered by Social Security. With minor exception
most federal civilian employees contribute 7 percent to the Civil Serv-
ice Retirement System ; this same rate also applies in nearly one-fifth
of the state and local pension plans in which employees are not covered
by Social Security.
TABLE F5. — DISTRIBUTION OF PUBLIC EMPLOYEE RETIREMENT SYSTEMS BY THE RATE OF
EMPLOYEE CONTRIBUTIONS
Percent of plans (with single rate only)
Less
3 to
4 to
5 to
6 to
7 to
8 to
9 to
10 or
System category
than 3
3.9
4.9
5.9
6.9
7.9
8.9
9.9
over
Total
Federal Government
33.3
11.1
11.1
44.4 .
100
State and local government:
1. By level of administration:
Slate administration
.6
12.9
4.7
21.4
42.7
10.0
3.9 .
3.8
100
Local administration.
13.1
10.8
10.6
28.8
11.8
15.5
8.9
"\y
.1
100
II. By social security coverage:
Covered systems...
.. 18.4
8.8
8.1
33.5
15.1
9.9
5.9
.3 .
100
Systems not covered
.. 5.5
13.0
11.5
22.9
15.5
19.5
10.7
.3
" i.T
100
III. State and local total 11.7 11.0 9.9 28.0 15.2 14.9 8.4 .3 .6 100
Note: Data relates to table 19 in App. I.
139
While the single rate type is the most common employee contribu-
tion formula, it can be seen from Table F6 that over one fourth of the
state and local government employees contribute on another basis.
Nearly 14 percent of such employees contribute at a lower rate on
annual pay below a certain dollar breakpoint and at a higher rate of
pay above the breakpoint. The breakpoint for most plans is under
$10,000 and is related to prior maximum taxable Social Security wage
base levels, $4,800 being the most common breakpoint. The contribu-
tion rate which applies to pay below the breakpoint is usually in the
2-3 percent range with the rate above the breakpoint several per-
centage points higher, usually 5 percent or 6 percent. There is a wide
variation in such rates, however, similar to that shown in Table F5.
In only 1.2 percent of the state and local plans are contributions based
on a rate applied solely to the excess pay above the breakpoint.
For about 11 percent of the employees in contributory plans the
contribution rate is actuarially determined, or otherwise varies by age,
sex, or length of service. Generally the use of actuarially determined
employee contribution rates had its origin in plans in which employees
were expected to meet 50 percent of the actuarial cost of the plan
with the employer meeting the other 50 percent through matching
contributions. Actuarially determined contribution rates are still of
importance in public pension plans and continue to apply to over 35
percent of the employees in locally-administered plans. The issue of
whether actuarially determined rates (especially rates which vary by
sex) are legally permissable is discussed in Part II of this report.
Employee contribution rates of the flat or fixed dollar type are of
relative unimportance in public pension plans, except that nearly all
volunteer firefighters contribute on such a basis.
TABLE F6— MANDATORY EMPLOYEE CONTRIBUTION FORMULAS UNDER PUBLIC EMPLOYEE RETIREMENT SYSTEMS
Percent of employees under plans with mandatory contributions
Single
Step
Actuarially
Excess
Flat
System category
rate
rate
determined
rate
rate
Total
1. Federal..
97.4
2.6
100
II. State and local:
A. State administration
78.2
14.0
5.9
1.4
.5
100
B. Local administration
51.1
13.2
35.4
.2
.1
100
C. Total
73.4
13.8
11.1
1.2
.5
100
SOURCE OF EMPLOYER CONTRIBUTIONS
The sources to which governments turn to finance public pensions
reveal the varied and unique nature of the public employee retire-
ment system. More than one-third, but less than a majority, of all
federal, state, and local pension systems are financed from revenues
raised under an unrestricted general taxing authority (although a
practical limit of taxation obviously exists at the point where the
citizens are no longer able or willing to pay). For the remaining plans,
which compose a majority of all public employee retirement systems,
employer contributions are derived from revenues which are limited
by statute or in some other way.
74-365—78 10
140
With minor exception, the revenue sources supporting employer
contributions to pension plans covering state employees are not
subject to limitations relating to tax rates or tax bases. However, in
most cases the contributions to such plans are subject to the appro-
priation processes within the states. As a result, state employee
pension plans usually have to compete with other state programs for
their funds. In some states (see Appendix V), statutory funding
requirements would appear to give state pension plans a priority
claim on state revenues. However, such claims may have less sub-
stance than the laws seem to prescribe. For example, the Illinois
Supreme Court recently upheld the right of the Governor to reduce
state pension fund appropriations below statutorily mandated levels.2
As discussed in the next chapter, many pension plans in addition
to those in Illinois have recently had their pension contributions
reduced below previous levels. Even though states possess broad
powers to raise revenues, it is clear that as pension fund needs consume
an increasing proportion of state budgets, practical considerations of
an economic and political nature have led to reductions in pension
financing. In fact, some states may have the legal right to curtail
pension benefits as well as financing levels when pension costs become
too burdensome or threaten the state's fiscal stability (the Tennessee
Supreme Court recently made this point).3 (See also Part III of this
report). The foregoing suggests that even at the state level pension
plans cannot fully depend on the broad-based taxing powers of the
state to supply ever increasing or unlimited revenues to meet pension
costs.
Generally, the sources available to local governments for pension
financing are much more restricted than is the case at the state level.
The employer contributions to less than one-half of the pension plans
covering local government employees are backed by a "general taxing
authority without limitation" (see Table 48, Appendix I). The revenue
sources backing the majority of local government plans are therefore
restricted in some manner.
The employer contributions to nearly 15 percent of the pension
plans covering local government employees (principally plans covering
policemen, firefighters, and teachers) are derived from special taxes
levied for the specific purpose of financing pensions. In addition, 5
percent of the police and fire plans administered at the local level and
13 percent of such plans administered at the state level are financed
exclusively from revenues from state premium taxes on fire and cas-
ualty insurance. Nearly 50 percent of such plans are financed at least
in part by state insurance premium tax revenues.
Kestrictions on the sources of financing for local government pension
plans have caused funding problems for many local plans. For the
most part, the formulas used to allocate fire and casualty insurance
premium taxes to police and fire plans do not relate to the funding
needs of the plans, thus causing some plans to be underfunded at the
same time others are being overfunded.4 Maximum tax rates set by
state law have prevented some local plans from achieving adequate
1 U.S Congress. House Committee on Education and Labor, Subcommittee on Labor Standards, The
PuUic Employee Retirement Income Security Act of 1976: llearingt on II.R. 9165 and II. R. 808 (Washington,
D.C.: U.S. Government Printing Office, l'J76), p. 319.
* See Article by Neal R. Peirce in the Washington Post, August 27, PJ77.
* See footnote 2, p. 71.
141
financing.5 For example, the city of Englewood recently sued the
State of Colorado charging the state pension financing law to be
"unsound".6
Even though states may restrict the level of local pension plan
financing, the states may be under no legal obligation to guarantee
pension programs set up by local governments, as the Attorney
General in Michigan recently ruled.7 Nonetheless, state subsidies now
constitute the major source of system financing for over 7 percent of
the total plans covering police, firefighters, and teachers. In an addi-
tional 25 percent of the locally-administered plans and nearly 40
percent of the state-administered plans covering local government
employees, state subsidies provide a substantial supplemental source
of system financing.
Local governments as well as some state governments look increas-
ingly to federal revenues as a source of retirement system financing.
For example, over one-third of the third class cities in Pennsylvania
have turned to federal revenue sharing money to remedy inadequate
pension financing.8 The State of Delaware currently deposits 100 per-
cent of its Federal Revenue Sharing funds into its State Public
Employees Retirement System.9 Federal grant program funds also
represent a significant and growing source of state and local
government pension plan contributions.
In general the employer contributions to the federal retirement
systems covering civilian employees, the uniformed services, and the
judiciary are appropriated from general revenues of the U.S. Govern-
ment. However, the pension contributions of some federally-related
agencies and instrumentalities are derived from the operating revenues
of such entities. Therefore, agency operating revenues, and possibly
not the full faith and credit of the U.S. Government, serve to guar-
antee adequate financing for the pension plans covering Federal
Reserve Board/Bank employees, Federal Home Loan Bank employees,
Farm Credit District employees, Federal Home Loan Bank em-
ployees, Nonappropriated Fund (service exchange) employees, and
persons entitled to benefits under the Panama Canal Zone Relief
Program.
Similar to the above federal-related plans, about 2 percent of the
plans covering 4.3 percent of all public employees at the state and
local government level are "quasi-governmental" in nature. The
employer contributions to such plans are usually derived solely from
the operating revenues of the employer entities — for example transit
fares, bridge and tunnel tolls, pari-mutuel proceeds, hospital charges,
water, sewage, and electricity charges, etc. In many cases the issue
has not been resolved regarding whether the pension plans of these
quasi-governmental entities meet the definition of "governmental
plan" under ERISA which would exempt them from the Act. An
important determinant of the financial strength of these quasi-
governmental pension plans is whether the state or local governments
creating or chartering such organizations have a legal obligation to
4 See footnote 2, p. 64.
• "Englewood Sues State Over 'Unsound' Pension Law", Denver Post, December 8, 1976.
7 See "The Public Pension Morass", speech of Representative Dan Angel of Michigan, delivered before
the National Seminar on Public Pension Issues, Washington, D.C., September 15, 1977.
8 See footnote 3. p. 42.
5 Letter to Pension Task Force dated December 7, 1977 from Mr. Ronald F. Mosher, Delaware State
Budget Director.
142
guarantee the financing for such plans in the event operating revenues
are inadequate.
In summary, the financing of federal, state, and local pension plans
is related more to the overall financial structure of the various govern-
mental units (and the ability and willingness of the citizens to pay
taxes to such units) than to the mere constitutional or statutory
provisions authorizing unlimited powers of taxation. The financing of
many pension plans covering local government employees lacks
stability and predictability due to state imposed taxing restrictions as
well as to the indeterminate amount of funds available from federal
revenue sharing, state insurance premium taxes, etc.
Chapter G — PEES Funding
The alarm has been sounded on many occasions as to the inadequate
funding of some public employee retirement systems. The concerns
expressed twenty years ago as to the "considerable degree of ... .
cost blindness existing in many pension plans for government em-
ployees" have been repeated with a greater sense of urgency in the
1970's.1 A 1973 report by the Advisory Commission on Intergovern-
mental Relations concludes that "underfunded, locally administered
retirement systems pose an emerging threat to the financial health of
local governments." 2
The results of the Pension Task Force survey show the accumulated
effects of the broad range of practices that characterize federal, state,
and local government pension funding. While many plans are presently
experiencing or will soon experience funding problems in the form of
high and continually escalating pension costs, at the other end of the
spectrum some pension plans have accumulated substantial reserves
which will better enable these plans to keep future contributions from
increasing to more burdensome levels.
Several different techniques have been employed in this study in an
effort to deal with the confusion in which most discussions of public
pension plan funding are enshrouded. The lack of any uniformity of
terms, measures, or standards relating to public pension funding has
heretofore presented a major obstacle to a meaningful analysis or
comparison of the funding status of these plans. For example, there
are no singular definitions for such widely used terms and concepts
as actuarial funding, unfunded liability, actuarial soundness, or
adequate funding.
However obscure such actuarial terms and funding concepts have
proved to be in the past, they cannot serve to mask the ultimate
effects of public pension plan underfunding (on whatever basis such
term may be defined) . The effects of public pension plan underfunding
are clearly illustrated by —
(1) the relatively high and continually increasing contribu-
tions experienced by some plans — e.g. annual benefit payments
equaling the employer contributions for the federal Military
Retirement System have reached 40 percent and now approach
50 percent of the system's covered payroll for active members, and
the pension payroll costs of the poorly funded plans in a half-
dozen large cities and many smaller ones approach or exceed the
experience of the unfunded federal plan;
1 Dorrance C. Bronson, Concepts of Actuarial Soundness in Pension Plans (Home wood, Illinois: Richard
D. Irwin, Inc., for the Pension Research Council, 1957).
2 U.S., Government, Advisory Commission on Intergovernmental Relations, City Financial Emergencies:
The Intergovernmental Dimension (Washington, D.C.: U.S. Government Printing Office, 1973), p. 6.
(143)
144
(2) the required doubling of employer contribution levels for
some plans seeking to make amends for past underfunding 3 —
if an increasing number of plans take such, corrective steps in the
near term it will undoubtedly lead to an acceleration of the in-
crease in the average rate of employer and employee contributions
which presently stands at about 18 percent of covered payroll for
all public pension plans;
(3) the temporary pension plan insolvencies and pensionless
apa3r-days" experienced by several local plans.4
In many instances state and local authorities may be unaware of
existing or developing funding problems. About 24 percent of all plans
have either never had an actuarial valuation or last did so more than
ten years ago. The financial emergencies and budgeting problems of
some state and local governments have begun to affect even those
plans which in the past have paid close attention to pension costs and
have accumulated pension reserves on a methodical basis. To achieve
balanced budgets some governments have reduced pension contri-
butions, in some cases below statutorily mandated levels, while others
have resorted to benefit curtailments in various forms.
Because most pension funding problems develop gradually, there
has been a tendency for past generations to shift the burden of solving
these problems to future decisionmakers. Because of the long-term
nature of pension plans, such funding problems can usually be solved
on a gradual basis over a period of time. There is evidence that some
plans have recognized these facts and because of their growing prob-
lems have begun to take the steps necessary to provide for future
funding on an actuarial reserve basis.5
The next section covers the growing consensus on the need for
reserve funding and the wide range of opinion as to the criteria which
should be used to define the minimum level of reserve funding for
public pension plans.
NEED FOR RESERVE FUNDING
Because of the lack of a uniform pension terminology, any discussion
of pension funding must necessarily be preceded by a definition of
terms.6 In the pension plan context the term "funding" suggests an
associated accumulation of a fund of assets. However, some authorities
define "pension funding" in more general terms to mean any financial
arrangement providing for the timely payment of pension benefits.
3 For example, recommendations to double contributions were recently made for the plans in two states;
see Massachusetts, Government, Report of the Funding Advisory Committee and the Retirement Law Com-
mission to the Governor and General Court of Massachusetts (Boston, 1976), and James C. Hyatt, "Day of
Reckoning: States Struggle as Past Problems Spur Spurt in Pension Costs," in the Wall Street Journal,
June 25, 1973.
4 For example see the experience of Hamtramck, Michigan in footnote 2 above, pp. 36-10; problems of
Toledo, Ohio and Lakewood, Ohio are mentioned in Labor Management Relations Service, National
League of Cities, National Association of Counties, and United States Conference of Governors, Philip M.
Dearborn, Jr., "Pensions for Policemen and Firemen Special Report," (Washington, D.C, 1975).
4 For example, see the report of the Massachusetts Retirement Law Commission in footnote 3, and th«
Report by the House Committee on the District of Columbia on the District of Columbia Retirement
Reform Act, Report No. 95-335, 95th Congress, 1st Session, which provides for federal financing and actu-
arial funding of three District of Columbia plans which are currently maintained on a pay-as-you-go basis.
4 The reader is referred to the Interprofessional Pension Actuarial Advisory Group Pension Terminology
Report of October 1, 1977, which was published in the P>NA Pension Reporter on October 3, 1977. This
report cross-references most of the actuarial terms in common usage. Other basic references on pension
terminology include Charles L. Trowbridge, Fundamentals of Pension Funding, Transactions of the
Society of Actuaries, Volume IV, No. 19, and Dan M. McGill, Fundamentals of Private Pensions, Third
Edition, (Homewood Illinois: Richard D. Irwin, Inc., for the Pension Research Council, 1975).
145
For purposes of this report 1 'pay-as-you-go funding" (sometimes
called the current disbursement approach) means the financing ap-
proach whereby the employer contributes only that amount necessary
to meet the employer's share of current benefit payments. For con-
tributory public pension plans this approach may be accompanied
by the accumulation of employee contributions in a fund.
On the other hand, ' 'reserve funding" (or advance funding) will
mean a financing arrangement whereby the employer contributes an
amount in excess of the employer's share of current benefit payments.
Under such an approach the excess contributions accumulate in a fund
along with employee contributions, if any. Reserve funding may be on
an actuarial or non-actuarial basis. " Actuarial funding" means the
special case of reserve funding whereby an "actuarial valuation
method" is utilized as the basis for determining the amount of the
employer's contribution.
An "actuarial valuation (or cost) method" is a procedure, using
actuarial assumptions, for measuring the expected value of a plan's
future benefit payments and assigning such value to particular time
periods (e.g. past years, the current year, and future years). That part
of the expected value assigned to the current year is commony referred
to as the "normal cost" (other terms in use are current service cost,
future service cost, and annual actuarial value). That part of the total
expected value of future benefit payments reduced by the value of
future normal costs (and future employee contributions, if any) is
commonly referred to as the plan's "accrued liability" (other terms in
use are past service cost or liability, actuarial liability, supplemental
present value, and supplemental actuarial value). The accrued liability
reduced by the actuarial value of plan assets is referred to as the "un-
funded accrued liability" (or unfunded past service liability, etc.).
A pension plan which adopts actuarial funding will usually provide
for annual contributions in an amount equal to the normal cost and a
portion of the unfunded accrued liability. The latter portion may be
an amount calculated so as to provide for the complete amortization of
the unfunded accrued liability over a specified period, such as 30 or 40
years. The amount may be level in dollar terms (as required under
ERISA), or it may be calculated as a level percentage of payroll which
generally results in increasing dollar amounts over time. Other
amounts may also be contributed such as an amount equal to interest
on the unfunded accrued liability.
Under some actuarial cost methods, a pension plan may be said
to be "fully funded" when the unfunded accrued liability has been
fully amortized. Under other actuarial valuation methods the un-
funded accrued liability may be "frozen" at an arbitrary level or
may be equal to "0" at all times by definition. This fact as well as
others relating to present actuarial practices (which are discussed
later) has heretofore prevented any study from utilizing "unfunded
accrued liability" as a comparative tool or meaningful measure of
the funding status of the public emplo}^ee retirement sj^stem as a
whole.
As shown in detail in the next section a near majority of all public
pension plans have opted for some form of actuarial funding. The
arguments in support of reserve funding are compelling and have
148
been recognized by every state and the federal government for some
of the plans in each jurisdiction. Many authorities offer discussions
of the following advantages of reserve funding for public pension
plans.7
1 . A primary purpose of reserve funding is to give formal recognition
to ultimate pension costs b}r allocating a portion of such costs on a
current basis. In other words, the cost of an employee's pension should
be allocated to each year of active employment and not deferred
beyond retirement. The United States General Accounting Office
has observed that this promotes sound fiscal and legislative responsi-
bility and enhances budgetary discipline.8 Another authority explains
this principle in the following way, "Real discipline for public policy
is exacted only by the need to pay now for benefits enacted now." 9
2. A corollary to the first advantage given for reserve funding is
that the cost of benefits related to the service of present active members
should be borne by present taxpayers and should not become a lia-
bility to future taxpayer generations.10
3. Another strong argument favoring reserve funding is that a
funded system secures the pension rights of members by insuring
that the necessary money will be available to meet pension claims
as they become due. The importance of an accumulation of funds
is underscored by several recent plan insolvencies placing benefits
in jeopardy (cited earlier) as well as by the steps taken in some plans
to curtail pension benefits (see Chapter D). Reserve funding lowers
the ultimate contribution level needed to finance a pension system
thereby lessening the chance that a governmental unit will ever be
faced with a legal test as to its commitment to honor present or
future employee pensions.
4. Building on this last point, it is argued that the investment
income earned on the assets of a reserve funded system reduces the
ultimate level and aggregate amount of contributions needed to
finance the system, thereby reducing the burden of the taxpayers or
employees who ultimately pay the costs. The percentage of benefit
costs met by investment earnings is dependent on the level of reserves
maintained by a pension system over time. The larger the reserve and
the earlier it is built up, the larger will be the ultimate contribution
savings. Typically for actuarially funded plans the investment
earnings will meet 25 to 50 percent of total pension costs.11 For one
previously unfunded system it was determined that a continuation
of the pay-as-you-go approach would result in ultimate contribution
levels about 89 percent above those required if ERISA funding
standards were followed.12
As applied to ongoing public pension plans, the arguments made in
the past in support of pay-as-you-go financing are now fading and
seem pale in comparison to the arguments presented above in support
7 See references given in footnotes 5, 8-10, and Illinois, Government, Report of the Illinois Public Employees
Pension Taiws Commission (Springfield. Illinois, 1973).
' U.S. General Accounting Office. Report to the Congress by the Comptroller General of the United States:
Federal Retirement Systems: Unrecoqnized Costs, Inadequate Funding, Inconsistent Benefits (Washington,
D.C.: U.S. Government Printing Office, 1077), p. 5.
■ Robert Tilove, Public Employee Pension Funds (New York, New York: Columbia University Press,
1976). p. 134.
"•Thomas P. Bleakney, Retirement Systems for Public Employees (Homewood, Illinois: Richard D.
Irwin, Inc., 1972), p. 113.
" For example, see William F. Marples, Actuarial Aspects of Pension Security (Homewood, Illinois:
Richard D. Irwin, Inc., 1965).
11 See page 38, U.S. House of Representatives Report No. 95-335, as given in footnote 5.
147
of reserve funding. Some have observed that the pay-as-you-go
approach embodies administrative simplicity and obviates the need
for a periodic actuarial valuation or analysis. While a significant
number of pay-as-you-go plans have had recent actuarial valuations,
nearly one-fourth of all public plans have avoided having an actuarial
anal}rsis of emerging pension costs. Such practices should be branded
for what they are — neglectful and unsound.
Such inattention to pension finances will undoubtedly catch some
plan officials unaware of sharp pension cost increases and fluctuations
which could precipitate future financial emergencies. It is argued,
correctly, that reserve funding offers substantial protection to govern-
mental units from the results of adverse financial experience.13
Yet today 17 percent of all public pension plans are still found to
be operated on a pay-as-you-go basis. A large part of the historical
resistance to reserve funding probably relates to the argument that
to do otherwise " would cost too much." Undoubtedly, for some of
these plans the current benefit costs as a percentage of active member
payroll already exceed the contribution levels that would have been
required had such plans been initially funded on an actuarial basis.
Of course any continued delay on the part of such plans to change
from a pay-as-you-go to an actuarial funding basis will continue to
push the required actuarial contribution levels higher and higher.
The situation can be illustrated as follows.
For example, if an employer is presently contributing 12 percent of
payroll to meet benefit payments on a pay-as-you-go basis, a change
to actuarial funding may require contributions to be increased to a
level of, say, 25 percent of payroll (up from the 15 percent that would
have been required initially). If the actuarial approach is rejected as
"too costly", the contributions required under the pay-as-you-go
approach may, in a span of 15 years or so, reach the 25 percent level
anyway. Without the benefit of actuarial funding such contributions
could continue to climb, ultimately leveling off at 50 percent or
even 75 percent of payroll.
Given the above circumstances where pension contributions of
25 percent of payroll are "too costly" today, serious consideration
must be given to the questions why payment levels of 25 percent will
not be too costly 15 years hence and why payment levels of 50 percent
will not be too costly, and perhaps cut back, 30 years hence. Ulti-
mately, the advocates of pay-as-you-go financing resort to the argu-
ment that regardless of how high pension contributions may rise, the
unlimited power of government to tax serves as an adequate guarantee
of such payments.
The findings of the Pension Task Force prove the universal appli-
cation of this assumption to be a fallacy. Some jurisdictions have
already had to face the hard truth that permanency does not, in and
of itself, guarantee solvency and that the ability to tax is in fact
limited by the ability and willingness of the citizens to pay. This is
particularly evident at the state and local level of government where
13 Some pertinent questions for study that might be asked here are (1) what additional financial strains
would have been placed on New York City during its recent fiscal crisis if the City's pension plans had
always been financed on a pay-as-you-go basis rather than on the statutorily mandated reserve basis? and
(2) to what extent did the fact that New York City had accumulated substantial pension reserves serve as
a margin of safety thus aiding the city in paying pens'ions on a timely basis as well as in avoiding bankruptcy?
More than likely the results of such a study would demonstrate the merits of reserve funding for public em-
ployee retirement systems (see footnote 14).
148
in some cases acute as well as chronic financial difficulties have led to
reductions in employee benefits, employer contributions, and employee
benefit security. Financial problems leading to the erosion of employer
contributions and employee benefit security is poignantly illustrated
in one case where the ratio of plan assets to active member benefit
liabilities decreased from 51 percent to 12 percent over a 12 year
period.14
In numerous instances local governments cannot rely on increased
tax revenues to meet rising pension costs because of statutory restric-
tions on local tax rates.15 As a practical matter it is clear that even
state governments can and will renege on present or future pension
commitments when pension costs become too burdensome or threaten
the governmental unit's fiscal stability.16 The presence in some states
of contractual and constitutional provisions prohibiting the ' 'impair-
ment or diminishment of accrued pension rights" may also be in-
effective in forcing governments to raise revenues to pay benefits
(see Part III of this Report for an expanded discussion of the legal
aspects of such provisions). Buttressing this last point is the fact that
state statutes requiring plans to fund at prescribed levels have in
some cases proved ineffectual in causing state and local governments
to appropriate the required contributions.17
The many factors-legal, economic, political, etc. — which serve to
limit a government's ability to raise revenue for pension or other
purposes differ in form and scope at the different levels of government.
Municipal governments are less able to offer complete pension security
to employees in unfunded and underfunded plans than are state
governments. The federal government is in the enviable position of
providing its employees with the largest measure of pension security
because of its broader tax base and greater borrowing ability. For
these reasons the argument that the pay-as-you-go or other minimal
14 See the following table:
NEW YORK CITY RETIREMENT SYSTEMS— SELECTED DATA, 1962 AND 1974
[Dollar amounts in millions]
Reserve for Percent of
employee Reserve for Reserve for Liability active
Total contribu- retired active for active liability Total
System assets tions members members members funded liabilities
Employees:
1962
$1,646
1974
3, 572
Teachers:
1962
1,209
1974
2, 386
Board of education:
1962.
59
1974
130
Police:
1962....
277
1974
1,154
Fire:
1962
108
1974.
476
$600
$341
$705
743
2,215
614
398
544
267
394
1,632
360
24
18
17
32
71
27
100
30
147
147
770
237
21
27
60
37
280
159
$1,376
51.2
$2,317
5, 183
11.8
8, 141
1, 179
22.6
2,121
4,618
7.8
6, 644
56
30.4
98
183
14.8
286
675
21.8
805
2,227
10.6
3, 144
403
14.9
451
1, 134
14.0
1,451
Source: New York State Insurance Department.
15 For example, see U.S. Congress, House, Committee on Education and Labor, Subcommittee on Labor
Standards, The Public Employee Rdirement Income Security Act of 1975: Hearings on H.R. 9155 and H.R. 808
(Washington, D.C.: U.S. Government Printing Office, 1976), p. 64.
18 For example, the Tennesseo Supreme Court recently made this point; see article by Neal R. Peirce in
the Washington Post, August 27, 1977.
O For example, see footnote 15, p. 319.
funding practices found at a given level of government are therefore
appropriate for use by all lesser governmental units must be rejected
as a fallacy. Also, it cannot be assumed that pension payments that
become unaffordable will be financed by higher levels of government,
because even at the state level there may be no legal obligation to do
so.18
Additional arguments have been made in the past to justify the
pay-as-you-go funding of the plans covering the federal judiciary and
uniformed services.19 Because employees do not contribute under
these programs, it has been said that the federal government has no
"quid pro quo" obligation to make employer contributions. Secondly,
it is argued that payments under these programs have the special
nature of "retired pay" in that recipients may continue to perform
intermittent duties or may be subject to recall. Also, it is argued that
the military and judicial retirement payments may be deemed to have
a priority position on federal tax receipts over the retirement pay-
ments to less glamorously placed federal employees.
The above case made in support of pay-as-you-go financing may
be found, even for federal plans, to be less persuasive than the four
arguments in support of reserve funding presented earlier. After
studying these various concerns, the General Accounting Office made
the following recommendation in August, 1977:
The Congress should enact legislation requiring that the full cost of federal
retirement systems be recognized and funded and that the difference between
currently accruing cost and employee contributions be charged to agency
operations.20
Others studying the federal situation have also recommended that
budgeting based only on the current retirement "pay out" be pro-
hibited.21
The arguments in favor of reserve funding have also proved per-
suasive to the retirement commission members of the last state to
formally defend pay-as-you-go financing.22 If adopted, the recom-
mendations made by the Massachusetts Retirement Commission in
October 1976 to fund all of the state's pension plans on an actuarial
basis would reverse the policy set by a special commission in 1945 to
place "all contributory retirement systems ... on a non-reserve basis
insofar as public funds are involved." 23 It remains to be seen whether
the growing consensus on the need for public pension plan reserve
funding will alter the pay-as-you-go financing practices found in 17
percent of all federal, state, and local plans.
While there appears to be a consensus developing on the need for
reserve funding for public pension plans, there is no accompanying
agreement as to what the minimum reserve funding basis should be.
Some advocate the use of various actuarial valuation (cost) methods
to determine contribution levels while others are less insistent on the
18 For example, in Michigan the Attorney General has ruled that the state "is under no legal obligation to
guarantee pension programs set up and operated by local governments." See "The Public Pension Morass,"
speech of Representative Dan Angel of Michigan, delivered before the National Seminar on Public Pension
Issues, Washington, D.C., September 15, 1977.
19 See footnote 1, p. 150.
30 See footnote 8, p. 1.
21 Statement of Admiral Hyman G. Rickover, U.S. Navy, to the Committee on Post Office and Civil
Service, U.S. House of Representatives, July 26, 1977.
23 See Massachusetts Report in footnote 3, p. 1.
33 Massachusetts, Government, Report of the Special Commission Established for the Purpose of Making a
Further Investigation of the Retirement Systems of the Commonwealth and of the Political Subdivisions Thereof,
House Report No. 1950, (Boston, 1945).
150
use of actuarial methods as long as plan assets are maintained at
certain minimum levels.
Among those recommending the use of the actuarial valuation
method approach to funding is the United States General Accounting
Office (GAO). The GAO recommends that all federal plans be funded
on a dynamic normal cost basis. This approach does not spell out the
particular actuarial valuation method to be used or on what basis the
"unfunded accrued liability" should be funded (in those cases where
the actuarial method adopted provides for such a figure). The GAO
does specify that the normal cost be calculated on a "dynamic basis"
(i.e. where future cost-of-living increases and general pay increases are
taken into account in the calculation).24
Others suggest that minimum employee and employer contribution
levels equal to normal cost plus interest on the unfunded accrued
liability may be appropriate when certain assumptions can be made
about the governmental unit's continuity and ability to pay.25 In
addition, some suggest that contributions be calculated in such a man-
ner that the unfunded accrued liability be amortized over a fixed
period of years (e.g. 30 or 40 years). In the public pension context it is
often suggested that these payments on the unfunded accrued lia-
bility be calculated as a level percentage of pa}Toll rather than as a
level amount as required under ERISA.26
Additional criteria may be added to the various funding approaches
in order to define a targeted level of funding adequacy. One public
pension plan actuary suggests that "the total assets of the system
should never be less than the sum of the balances in the members'
accounts and in the retired reserve fund since these might both be
considered as representing liabilities that should be fully funded at
any given time." 27 Another criterion often suggested is that assets bear
a certain minimum ratio to benefit pa} ments (e.g. assets equal to 10
times benefit payments).28
As can be seen there is no universally recognized "best" set of cri-
teria defining a minimum standard of reserve funding. Even if a mini-
mum standard were to be recognized, it would be equally important
to include in the definition the basis on which the actuarial assump-
tions should be chosen. An appreciation of this fact is crucial to an
understanding of the complicated actuarial aspects of pension plan
funding. For example, the normal cost calculated under a "dynamic"
set of actuarial assumptions may for a given plan be greater than the
normal cost plus interest on the unfunded accrued liability calculated
for the same plan under a set of assumptions which ignores future
benefit increases stemming from salary and cost-of-living increases.
The importance of actuarial assumptions is explored further in the
following sections.
PRESENT FUNDING PRACTICES
As early as 1916 a City of New York Commission on Pensions
found that city's public pension plans to be inadequately financed.29
14 Same as footnote 20.
15 See footnote 9, p. 167.
31 See Massachusetts Report in footnote 3, p. 5.
»7 Article by Kenneth H. Ross in The Actuary, November 1976.
»' For example, see statement of Senator Thomas Eagleton, Congressional Record, February 3, 1976, pp.
S1075-1076.
« New York, New York City, Government, Report on the Pension Funds of the City of Xetc fror/c, City
of New York Commission on Pensions, Part I (New York, 1916), pp. 76-77.
151
Shortly after the Commission's report was filed, the city adopted an
actuarial reserve basis on which to fund the city plans covering
teachers and general employees. As in New York City most early
pension schemes for public employees began as mere extensions of
governmental payroll operations. Unlike the New York plans, all of
which were eventually placed on an actuarial funding basis, a few
plans, even toda}r, continue to be operated on the turn-of-the-century
payroll concept. An extremely wide range of combined employee and
employer contribution rates to public pension plans has resulted from
the carry-over to the present of outdated funding practices by some
plans as well as the adoption of actuarial funding principles by other
plans. The combined contribution rates presently range from 0 percent
to over 70 percent of covered payroll and average about 18 percent of
covered payroll for all defined benefit plans (see Chapter F for more
detailed information on PERS finances).
The range of contribution rates for defined contribution plans is
much narrower, 5 percent to 25 percent, and the average rate is 3
percent to 5 percent less than the average rate for defined benefit plans
depending on the group strata chosen for comparison. Defined contri-
bution plans can be considered "fully funded" at all times, since a
participant's benefits at any given time are based solely on the amount
of contributions and earnings accumulated in the participant's
account. Because of this special nature of defined contribution plans,
they will not be considered further in this chapter.
Although, as discussed earlier, there appears to be a growing con-
sensus on the need for reserve funding of defined benefit plans, actual
practice lags behind such opinion as shown in Table Gl. The reasons
for the reluctance of some plans to change to a more adequate funding
basis may relate to limited revenues ("can't afford it"), to a general
unappreciation of the level of present and future pension benefits and
costs, or to an out-and-out neglect of pension matters.
TABLE Gl. — PUBLIC EMPLOYEE RETIREMENT SYSTEM FUNDING METHODS
Percent of defined benefit plans
Nonactuarial basis Actuarial basis
Normal Payment
cost paid less than
and normal
unfunded cost and
Normal accrued 40-year
Employer cost paid liability amorti-
matching and no amortized zation of
or other unfunded over 40 unfunded
Pay as Terminal nonactu- accrued years or accrued Un-
System category you go funding arial basis liability less liability known Total
Federal Government 34.8 7.0 44.2 14.0 100
State and local government:
State administration...
23.1
1.2
4.5
7.8
45.0
14.1
4.5
100
Local administration...
16.6
.1
26.0
17.9
25.8
7.2
6.2
100
State and local totals by sys-
tem coverage type:
State and local govern-
ment.
16.3
.1
5.5
24.0
42.3
5.3
6.4
100
Police and fire.
16.6
.2
31.2
15.6
22.2
8.2
5.8
100
Teachers (including
10.3
100
higher education)
42.1
1.1
3.3
4.4
28.4
10.4
Total
17.0
.2
24.7
17.4
26.8
7.7
6.1
100
Note: Data is a summary of that shown in table 52, app. I.
152
A rational funding policy is more likely to be absent from public
pension - plans that are not subjected to statutory funding guides
of some type. For example, in Pennsylvania, which exempts cities
from the state's statutory funding requirements, only five out of
thirty cities were found to have a written funding policy for their
police and fire plans.30 In contrast, ERISA requires, as part of the
general fiduciary responsibility provisions of Title I, Part 4, that
every private pension plan "provide a procedure for establishing
and carrying out a funding policy and method consistent with the
objectives of the plan." 31
As shown in Table Gl, at least 42 percent of all federal, state, and
local pension plans are presently funded on a non-actuarial basis.
As might be expected, the vast majority of such plans have neglected
having actuarial valuations performed in the past. This being the case,
it is doubtful that the officials responsible for such plans have knowl-
edge of the likely progression of pension costs under their plans as
presently structured or knowledge of the cost of benefits that may
have been added in the past.
About 17 percent of all public plans presently finance employer-
related benefits on a pay-as-you-go basis. The variation at the federal,
state, and local levels (34.8 percent, 23.1 percent and 16.6 percent,
respectively) does not represent a divergence of practice that the
percentages seem to suggest. If the relatively large number of judicial
systems at the federal level were treated as one plan, the percentage
of pay-as-you-go plans at the federal level would be nearly equiva-
lent to that found at the state and local level. In fact there are more
similarities than differences in the pay-as-you-go and other funding
practices to be found at the three levels of government. For example,
the plans covering uniformed employees at the federal level follow
a pay-as-you-go financing basis while nearly one-half of the uniformed
employee plans at the state and local level are funded on a non-
actuarial basis. Similar patterns are found at all government levels
for plans covering judges.
The high percentage, 42.1 percent, of pay-as-you-go plans in the
teacher category is due mainly to the prevalence of the current
financing practices found in the defined benefit portion of the 1 'combi-
nation' ' plans covering university faculty. Outside the funding
context, it is unclear to what extent the defined benefit portion of
such plans may be qualified under Section 401(a) of the Internal
Revenue Code (IRS Rev. Rul. 76-259 defines conditions under
which similar plans may become qualified). The reader is referred
to Table 52 of Appendix I for a more detailed presentation of the
data by plan type.
Less than 1 percent of all plans are funded on a "terminal" basis
which requires employer contributions at the time each employee
retires in an amount equal to the present value of the employee's pen-
sion benefit (reduced by the accumulated value of emplo}-ee contribu-
tions, if any). The terminal funding method and the one remaining
method shown in Table Gl as "non-actuarial" may under certain con-
ditions provide for a larger or more rapid accumulation of pension
30 Pennsylvania, Department of Community Affairs, Act 298 Report: 1976 Actuarial Study Analysis
Municipal Pension Funds (Harrisburg, 11)77).
2i ERISA, section 402(b)(1), 2S U.S.C.A. section 1102(b)(1);
153
reserves than might be obtained under an "actuarial" method. The
reason that 1 'actuarial funding" cannot automatically be relied on to
produce more "adequate funding" over a short term than "non-
actuarial" methods is discussed later.
The third non-actuarial funding basis is primarily found among
police and fire plans at the local government level. In some cases, the
employer practice may be to match employee contributions, but more
commonly the employer's contribution is related to some third source
of revenue (e.g. parking fines, a portion of a state's total premium
taxes assessed on fire insurance policies, etc.). The arbitrary basis on
which contributions are made to some plans under this category has
led to some unique problems. Whereas some plans may be "short-
changed" by arbitrary revenue allocations and remain underfunded,
other plans may receive revenue "bonanzas" resulting in their being
substantially overfunded.32 The source of some funding problems can
be traced to statutes setting forth contribution levels which do not
relate to the actuarial needs of particular plans.33
As shown in Table Gl, about two-thirds of the federal and state
plans and about one-half of the local plans use an actuarial valuation
(cost) method for determining the amount of plan contributions. As
discussed earlier, there is no universally accepted minimum funding
standard for public pension plans, and therefore, a wide range of
actuarial methods and techniques are emploj^ed in such contribution
determinations. Funding statutes that are applicable to some federal,
state, and local plans add various restrictions to the actuarial methods
and assumptions that may be utilized. See Appendices V through VIII
for a detailed description of the restrictions placed on the funding
practices of the major plans in each state.
About 44 percent of all plans fall into the first two actuarial funding
categories shown in Table Gl. Generally, the contributions to the plans
in these two categories are equal to normal cost plus an additional
amount which will amortize a given plan's unfunded accrued liability
(if any) over 40 years or less. The remaining 7-8 percent of all plans
shown in the third actuarial funding category provide for contribution
levels below those of the plans in the first two categories.
About 13 percent of all plans and 40 percent of the largest plans
in the third category provide for contributions at a level at least
equal to normal cost plus interest on the unfunded accrued liability.
The contributions for the remainder of the plans in the third category
are less than normal cost plus interest on the unfunded accrued lia-
bility. Some plans in this third category are in a transitional stage
between pay-as-you-go funding and full actuarial funding. For
example, one state plan's transitional scheme provides for a scale of
uniformly increasing percentages (reaching 100 percent after 15
years) to be applied to the combined normal cost and 40-year amorti-
zation payment on the plan's unfunded accrued liability.
In contrast to the third category, the first actuarial funding category
covers plans in which 100 percent of the normal cost is paid. In addi-
tion, plans in the first category have "no" unfunded accrued liability.
Si See footnote 15, p. 71.
83 "Englewood Sues State Over 'Unsound' Pension Law," Denver Post, December 8, 1976.
154
It cannot be assumed that a plan is "fully funded" or even ade-
quately funded (however that term might be defined) just because a
plan is shown as having "no" unfunded accrued liability. The reason
behind this seemingly illogical statement relates to the technical char-
acteristics of actuarial funding methods. For example, under one such
method, the so-called aggregate method, the unfunded accrued liabil-
ity is by definition always eaual to zero. It might be noted that the
aggregate method is a permissible method of funding under ERISA
and that ERISA's requirement to amortize the unfunded accrued lia-
bility over 30 or 40 years is inapplicable in this case. Even though the
imfunded accrued liability is not separately identified under the aggre-
gate method, more rapid funding may result under this method than
under other methods providing for 30 or 40 year amortization of the
unfunded accrued liability.
Plans using the aggregate funding method make up about 42 per-
cent of the total plans in the first actuarial funding category. The re-
maining 58 percent of such plans have completely amortized any
unfunded accrued liability that may have been calculated under other
actuarial funding methods in use. As shown in Table Gl, plans cov-
ering local government employees make up the bulk of the overall
percentage of plans in this category (17.4 percent).
The second actuarial funding category contains a somewhat larger
percentage of all plans, 26.8 percent, than does the first category.
While about 45 percent of all state and federal plans fall into this
category, less than 26 percent of all local government plans do so. All
of the plans in this category utilize an actuarial valuation method
which provides for the calculation of an imfunded accrued liability. It
should be noted that the unfunded accrued liability for any given plan
may vary over a tremendous range depending on the specific actuarial
method chosen for funding purposes. A discussion of the various
actuarial valuation methods reflected in this category — such as the
unit credit, entry age normal, and frozen initial liability methods —
is beyond the scope of this report. The reader may want to refer to
the discussions of actuarial methods given in the footnote references.34
As shown in Table Gl all but 17 percent of the plans in the public
employee retirement system exhibit some form of reserve funding. To
determine that a plan is reserve funded or even actuarially funded
does not, however, provide sufficient grounds to conclude that such a
plan is accumulating assets so as to enhance employee benefit security
(as defined under any of several measures which are presented in the
next section). The reasons underlying this fact bring into sharp focus
the dynamics and pressures which characterize the public employee
retirement system.
Today, as in the past, budgetary squeezes and financial problems of
every sort are found at every level of government. As a result of such
pressures, some state and local plans have experienced temporary and,
in a few cases, continual cutbacks in the scheduled amount of employer
contributions so as to reduce them below the levels required under their
stated funding policies, including statutory ones.35 This coast-to-
* For an explanation of the various actuarial valuation methods of funding, see the references given in
footnotes 6, "J, and 10.
« For example, actual contributions were reduced below statutorily mandated levels for police and fire
plans in Washington and for teacher plans in Illinois. For information on Washington, see "Public Pension
Plans— A Nationwide Scandal," by Trevor Armbrister, Rtadir's Digest, March llJ76, p. 51. For information
on Illinois, see footnote 15, p. 319.
155
coast phenomenon was much in evidence in the survey data which
showed that actual plan contributions in more than 15 percent of the
largest plans were 20 percent or more below the actuarially derived
levels required under their stated funding policies.
A related matter is the questionable practice used by some plans
of inflating plan assets by accrued but unpaid employer contributions.
In New York City, as one example, accrued but unpaid city contri-
butions amounted to more than 20 percent of the combined assets for
all five city plans.35
The Pension Task Force survey data was not adjusted for such
practices. Therefore the measures of employee benefit security shown
in the next following section are overstated.
While the level of employer contributions has been held down in a
direct manner for some plans, other plans which purport to be ac-
tuarially funded have utilized various techniques to trim current
contribution levels. One widely used technique is to exclude certain
benefits from the actuarial valuation and to meet the corresponding
benefit costs as they become payable. Automatic post-retirement
increases related to the cost-of-living, some disability benefits, and
some death benefits have been found to be excluded in this manner.
In some cases the excluded benefits may make up 25 percent or even
50 percent of the total pension costs of a plan. While pension reserves
may continue to accumulate under such plans, it would be misleading
to assume that "actuarial funding" in such cases will automatically
lead to relatively higher levels of employee benefit security.
The deliberate use of "static" actuarial assumptions also has the
effect of reducing actuarially derived contribution levels below the
levels calculated under realistic or "dynamic" assumptions. For
example, under the federal Civil Service Retirement System, which
ignores future general pay increases and cost-of-living adjustments,
the normal cost for contribution purposes is assumed to be about 14
percent of payroll while the dynamic normal cost is estimated at over
31 percent of payroll.37
Also a plan's unfunded accrued liability will invariably be lower
when calculated under a set of static actuarial assumptions. For
example, the above federal plan's unfunded accrued liability com-
36 See the following table.
NEW YORK CITY RETIREMENT SYSTEMS— SELECTED DATA 1974
[In millions]
Reserve for Reserve for Accrued but
employee retired unpaid city
contributions participants contributions .
Assets
Actual assets
(col. 4 less
col. 3)
(1)
(2)
(3)
(4)
(5)
$2, 215
1, 632
71
770
$672
532
25
252
$4,244
$3,572
2,386
130
1, 154
Teachers..
Board of Education.
Police
394
32
147
2, 918
155
1,406
563
Fire ,
37
280
87
476
Total
1,353
4, 968
1,568
9,286
7,718
Source: New York State Department of Insurance and New York, New York City, Government,
Pensions: A Report of the Mayor's Managevient Advisory Board (New York, 1976).
37 See footnote 8, p. 5.
74-365 — 78 11
156
puted,on a dynamic basis was found to be twice the amount com-
puted on a static basis.38 Discussed previously was the fact that 58
percent of the plans under the first actuarial funding category in
Table Gl, amounting to 10 percent of all plans, were shown as having
no unfunded accrued liability. The "fully funded" status for a large
number of such plans was derived on a basis utilizing static actuarial
assumptions. In the absence of figures based on realistic actuarial
assumptions, no conclusion should be reached as to the actual funding
progress made by such plans.
Some consider the use of static actuarial assumptions to be an
appropriate technique for achieving desired levels of funding. For
example, the intent of the legislation to fund the Civil Service Re-
tirement System on a "static" basis was to retard the growth of
unfunded liabilities and stabilize the fund. The U.S. General Ac-
counting Office observes that the intent of this legislation has not
been achieved.39 In other cases the use of static assumptions may
produce contribution levels adequate to achieve desired funding goals.
However, the evidence argues strongly against the use of static
assumptions in actuarial calculations which are intended to measure
true pension costs and plan funding progress. The results of using
static assumptions in such cases can only be misleading.
It is well-recognized that the key to achieving a particular funding
goal under an actuarial method rests with the validity and integrity
of the actuarial valuation. The refusal of some plans to adopt realistic
actuarial assumptions and to deliberately set their assumptions
so as to achieve a desired contribution level has been aptly described
elsewhere as actuarial "gimmickry."40 The fact that some plans
engage in such practices in order to reduce employer contributions
renders meaningless any broad-brush attempt to characterize "act-
uarial funding" as being synonymous with "adequate funding".
For some of the plans shown in Table Gl as being funded on an
actuarial basis employee benefit security is in fact deteriorating. For
example a 1975 study by the New York State Pension Commission
concludes :
The New York City pension systems have been steadily moving away from
the fully-funded concept — in large part because the city has chosen to use pension
underfunding as one method of balancing its operating budget. The result has
been a progressive deterioration in the financial adequacy of the City's retirement
systems. The City's refusal to adopt realistic actuarial assumptions has resulted
in a systematic failure to pay current pension costs, thereby increasing future
liabilities, and hence, the retirement contributions in future years.41
It should be noted that changes in the actuarial assumptions used
by four of the five New York City plans have been made subsequent
to the publication of the Shinn Commission Report.
Another factor which can serve to frustrate the classification and
characterization of actuarial valuation methods is the manner in which
the resulting unfunded accrued liabilit}^ is amortized. Some plans may
amortize the unfunded accrued liability as a level amount over a
» U.S. Congress, House Committee on Post Office and Civil Service, Communication from the Chairman'
of the United States Civil Service Commission Transmitting the 52d Annual Report of the Board of Actuaries
of the Civil Service Retirement System (Washington, D.C.: U.S. Government Printing Office, 1075).
*• Spo footnote 8. p. 8.
*• New York, Government, Report of the Permanent Commission on Public Pension and Retirement Sys-
tems: Financing the Public Pension Systems, Part I: Actuarial Assumptions and Funding Policies (New
York, 1075).
«> 8e« footnote 40, p. 30.
157
fixed period of years (as required under ERISA). Other plans, par-
ticularly the larger ones, may amortize the unfunded accrued liability
as a level percentage of payroll. The second approach will generally
produce current contribution levels much lower than the first even
though amortization occurs over the same period under both ap-
proaches. Under the second approach the unfunded accrued liability
will continue to increase until contributions are sufficient to meet an
amount equal to the interest on the unfunded accrued liability. Some-
times the pay of future employees, not yet hired, is factored into the
calculation under the second approach. The use of this "open -group"
technique may lead to even lower current contributions (and much
larger ones later) than might be produced otherwise.
Given the above facts about the "actuarial" funding practices of
public pension plans, the question might be asked as to how many
plans presently meet ERISA minimum funding standards. At first
blush it would appear that the plans in the first two funding categories
under "actuarial basis" in Table Gl meet ERISA's minimum re-
quirements pertaining to multiemplo3~er pension plans.42 In total,
44.2 percent of all federal, state, and local plans responded that
their regular contributions were at least equal to normal cost plus an
amount sufficient to amortize any unfunded accrued liability over
40 years or less.
However, a combination of factors serves to reduce (from 44 per-
cent to perhaps 20-25 percent) the percentage of public plans which
could technically meet all of ERISA's funding requirements. For a
significant percentage of plans at any given time actual contributions
may fall short of the actuarially required levels. The use of static or
unrealistic actuarial assumptions by some plans causes them to fail
ERISA's requirement that actuarial assumptions in the aggregate be
"reasonably related to the experience of the plan and to reasonable
expectations".43 The practice of some plans to amortize unfunded
accrued liabilities as a level percentage of payroll fails to meet ERISA's
requirement that amortization occur in level amounts. Finally
ERISA's requirement that actuarial experience gains and losses be
amortized over 15 or 20 years is not a practice commonly found in
public pension plans.44
For reasons similar to the above, only about 20-30 percent of all
public pension plans have contributions at least equal to normal cost
plus interest on the plan's unfunded accrued liability, which is the
minimum amount needed to keep the unfunded accrued liability from
increasing. There is a general misconception that a pre-ERISA IRS
rule required funding of this amount. While the above amount is not
a positive funding requirement for governmental pension plans either
pre- or post-ERISA, it is the case that this test is part of an IRS
"safe-haven" rule involving whether a qualified plan which completely
discontinues all contributions is a "terminated" plan for Internal
Revenue Code purposes.45 See Part II of this report for additional
information on the application of ERISA and Internal Revenue Code
provisions to public employee retirement systems.
« ERISA, Section 302, 29 U.S.C.A. Section 1032, 1.R.C. Section 412.
" « ERISA, Section 103(a)(4)(B), 29 U.S.C.A. Section 1023(a)(4)(B).
** See footnote 41:
43 U.S., Congress. Conference Report on the Employee Retirement Income Security Act of 1974, Report 93~
1280 (Washington, D.C.: U.S. Government Printing Office, 1974), p. 291.
158
In summary, it can be said that there is a concensus on the need for
reserve funding of public employee retirement systems which has led
to a trend away from pay-as-you-go financing. However, pressures
for increased benefits, in large measure focusing on post-retirement
cost-of-living increases, and tight budget situations have caused some
actuarially funded plans to resort to the practices described above in
order to hold down current contribution rates. Evidence of this re-
laxation of funding levels is given in the following section.
ACTUARIES, ACTUARIAL VALUATIONS AND ASSUMPTIONS
A realistic assessment of true pension costs is unknown for the vast
majority of the public employee retirement systems at all levels of
government. Nearly a quarter of all public plans operate in total
actuarial darkness while many other plans, some funded on an actu-
arial basis, exhibit varying degrees of actuarial cost blindness.
From the first two columns of Table G2 it can be seen that 36
percent of the federal plans, 24 percent of the state plans, and 40
percent of the local plans do not have actuarial valuations performed
on a regular basis. Most of the plans in the first column have never
had an actuarial valuation. Very few of the plans in the second column
have had actuarial valuations within the past five years. It might be
pointed out that the extent of actuarial neglect shown would have
been much more extensive had it not been for recent steps taken by
two states (which in combination have nearly one-fourth of all plans)
to require actuarial valuations.
On the other hand, about 60 percent of the federal plans, 70 percent
of the state plans, and 53 percent of the local plans did respond as
having actuarial valuations performed at least every three years. It
appears, for the most part, that such plans would presently meet
ERISA's requirement that an actuarial valuation be performed no
less frequently than every three years unless a more frequent valuation
is determined necessary by the plan actuary.46 About 45 percent of
all public plans have annual actuarial valuations, a practice followed
by most private pension plans.
TABLE G2— FREQUENCY OF PUBLIC EMPLOYEE RETIREMENT SYSTEM ACTUARIAL VALUATIONS
[Percent of defined benefit plans]
System category
None in last
10 yrs
Valuation
made but not
on a regular
basis
Valuation
made at least
every 3 yrs
Valuation
made every
4th yr or
more
Total
Federal Government .
34.0
2.1
59.6
4.3
100
State and local government by level of
administration:
State administration...
5.2
19.1
69.9
5.9
100
Local administration..
25.1
15.2
53.2
6.4
100
Total.
23.9
15.5
54.2
6.4
100
Note: Data relates to table 53 in app. I.
An actuarial valuation or projection is essential, if a true under-
standing of a pension plan's emerging pension costs is to be realized.
« ERISA, Section 103(d), 29 U.S.C.A. Section 1023(d).
159
The integrity of any actuarial valuation which purports to assess
future pension costs in a realistic manner is dependent on the use of
accurate data on plan participants and on the inclusion of all relevant
assumptions.
The reliability of an actuarial valuation is undermined if inaccurate
or incomplete information on participant dates of hire, dates of birth,
compensation, etc. is utilized without appropriate adjustment. In
some plans, particularly those of the multiple employer variety,
severe recordkeeping problems are encountered (see Chapter C).
Such recordkeeping problems, when unknown, have led to significant
errors in actuarial calculations and, when known, have led to the
refusal of a plan's actuary to perform the actuarial valuation.47
If an actuarial valuation is to produce meaningful predictive values,
there must be some assurance that the actuarial assumptions are
deliberately chosen to be reasonable approximations of future events.
Several provisions were written into ERISA in order to assure that
this principle is reflected in the choice of actuarial assumptions under
private pension plans. First, a person must meet certain experience
and education requirements in order to practice under ERISA as
an "enrolled actuary".48 Secondly, the enrolled actuary is directed
to utilize assumptions and techniques which "(i) are in the aggregate
reasonably related to the experience of the plan and to reasonable
expectations: and (ii) represent his best estimate of anticipated ex-
perience under the plan." 49
Generally, the actuarial practices of public pension plans are not
subject to the standards which ERISA applies to private pension
plans. The resulting nonconformity in actuarial practice as applied
in the public pension area has impaired the usefulness of some ac-
tuarial valuations as reliable predictors of true pension plan costs.
It is well recognized in the public pension arena that the one who
controls the actuarial assumptions also controls the level and timing
of employer contributions. This has led to a struggle among actuaries,
boards of trustees, state legislatures, elected officials and others over
the the ultimate control of such assumptions. For some plans the use
of particular actuarial assumptions is mandated by statute. For other
plans the retirement board may accept or reject recommendations
made by the plan actuary. Small plans, in particular, may rely solely
on the plan actuary to recommend adequate assumptions and contri-
bution levels.
However, just because actuarial assumptions may be chosen by an
"actuary" there can be no assurance that they meet any particular
standard of reasonableness or adequacy. In the public pension area
actuaries are not required to meet any minimum qualification stand-
ards (such as under ERISA). The officials in one state have expressed
their concern that conflicts of interest may compromise the recom-
mendations of some actuaries.50 The lack of standards applied to actu-
arial assumptions has also been the source of confusion and frustration
47 For an example of the type of problem, see Pennsylvania, Department of the Auditor General, Common-
wealth of Pennsylvania State Employees Retirement System Auditor General Report of Examination for the
Period January 1, 1973 December 31, 1974 (Harrisburg, Pennsylvania, 1976); in another case an actuary re-
signed after being unable to obtain reliable employee data, see New Orleans Times-Picayune, January 8,
*« ERISA, Section 3042, 29 U.S.C.A. Section 1242.
« ERISA, Section 103(a)(4)(B), 29 U.S.C.A. Section 1023(a)(4)(B).
60 See footnote 15, p. 73.
160
Tor public officials and employees faced with conflicting recommenda-
tions made by different actuaries.51
On the other hand, public pension officials have sometimes rejected
the recommendations made by a plan's actuary to replace outdated
actuarial assumptions with realistic ones based on more current experi-
ence. As described in a New York State Pension Commission report,
the direct consequence of such actuarial "gimmickry" was to under-
state true pension costs for all the pension plans in New York City.52
The extent to which the actual experience deviates from the assumed
experience for the New York City plans is shown in Tables G3 through
G5.
TABLE G3. — ASSUMED MORTALITY AS A PERCENTAGE OF ACTUAL MORTALITY AMONG SERVICE PENSIONERS
Final year of
latest
Percent
experience —
New York City retirement systems study
Men
Women
136.8
215.5
193.7
160.7
176.9
469.4
Board of Education 1971
100.2
100. 2
TABLE G4— ASSUMED MORTALITY AS A PERCENTAGE OF ACTUAL MORTALITY AMONG DISABILITY PENSIONERS
Final year of
latest
Percent
experience —
New York City retirement systems study
Men
Women
Employees 1970
Teachers... 1972
Police 1973
168.0
129. 1
335.5
136.2
166.6
Fire 1969
800.0
Board of Education 1971
106.0
106.0
TABLE 65.— ACTUAL AND ASSUMED AVERAGE SALARY INCREASES
[In percent]
New York City retirement systems
Actual
annual
average
salary-
increase 1
Assumed
annual
average
salary
increase
6.2
7.2
9.1
9.1
6.1
1.0
2.4
1.5
1.6
1.3
i Based on annual average increase for period 1969-74.
The mortality assumptions utilized until recently by four of the five
city plans were based on experience covering the period 1908-14. Not-
withstanding the assumptions to the contrary, New York City's em-
ployees appear to have secured for themselves an equitable share of the
advances in longevity which have occurred since 1908. However, they
f William N. Thompson, "Public Pension Plans: The Need for Scrutiny and Control," Public Personnel
Management (July-August 1977), pp. 212-214.
i See footnote 40.
161
had not been favored with recognition of this reality by those who
administer their pension plans. According to the assumptions that,
until 1977 were used by the trustees of the New York City Police
Retirement System, service pensioners would have died at almost
twice the rate that they had in the past. For firemen, the thinking
appears to be that they would have died at almost five times the rate
they had in the past. The absurdity of this situation is further com-
pounded by the assumptions utilized for service connected disability
and average salary increases, both of which substantially understated
actual experience. As can be seen in Table G6, the contributions for
all five plans would have been 38 percent greater if calculated under
a set of actuarial assumptions revised to take into account more recent
experience.
TABLE G6. — NEW YORK CITY RETIREMENT SYSTEMS COMPARATIVE COST ESTIMATES APPLICABLE TO FISCAL
YEAR COMMENCING JULY 1, 1976
Costs as determined by the City Revised costs on updated
actuary on present assumptions assumptions
Percent of Percent of
Amount salary Amount salary
Employees $588,000,000 24.0 $816,300,000 33.3
Teachers 380,900,000 27.5 506,900,000 36.3
Board of Education 20,000,000 26.0 25,400,000 33.0
Police 180,600,000 34.8 244,700,000 47.1
Fire 50,900,000 23.2 90,600,000 41.3
Total... 1,220,400,000 26.2 1,683,900,000 36.2
Source : New York City government, "Pensions : A Report of the Mayor's Management Advisory Board" (New York, 1976).
It should be noted that in 1977, in response to the recommendations
in the Shinn Report, new actuarial assumptions (including mortality
assumptions) which more nearly approximate realistic expectations
were adopted by four of the five New York City Retirement S3^stems.
The survey data presented in Tables 54, 55, and 59 of Appendix I
give an overall picture of the actuarial assumptions utilized by public
pension plans for their most recent actuarial valuation (most being in
1975).
The rate of interest assumed for valuation purposes is the most
critical one inasmuch as a small increase, for example from 5 percent
to 5.5 percent, can have a relatively large effect on plan normal costs,
increasing such costs in this case by 12-14 percent.53 The median
interest rate for all plans is 5 percent with over 90 percent falling in
the range from 4 percent to 6 percent. Larger plans with a median
rate of 5.5 percent are more likely to use interest rates in the 6-7
percent range. Only 2.6 percent of the large plans were found to use
rates in excess of 7 percent. About 11 percent of the plans used an
interest rate of 4 percent (or less). All available evidence indicates
that the overall distribution of interest rates for public plans, partic-
ularly for the larger ones, tracks fairly closely the range of interest
rates for private pension plans.54
53 For illustrations of pension cost changes resulting from changes in actuarial assumptions, see Howard
E. Winklevoss, Pension Mathematics: With Numerical Illustrations (Homeward, Illinois: Richard D. Irwin,
Inc., 1977).
54 For 1975, the ranee of the most common interest rate assumptions for private plans was from 4.8%
to 6.6% with an average of 5.66%. See paper presented by Carl H. Fischer at the 1977 annual meeting of the
Conference of Actuaries in Public Practice.
162
Concerning actuarial assumptions other than the interest rate,
however, the practices for a substantial percentage of public plans
were found to deviate from those utilized in private pension plans.
For example, 28 percent of all public plans basing benefits on final
compensation chose to totally ignore future increases in employee
compensation. "Salary scales" are not used for 14 percent of the
federal plans (including the Military Retirement System), 7 percent
of the large state and local plans, and 35 percent of the state and local
plans with less than 100 members. Actual pension costs for such plans
may be understated by 20-50 percent depending on the actual level
of future salary increases and other assumptions.55
Only 36 percent of the plans which do use a salary scale indicated
that they include an inflation component in their assumed rates of
salary progression. General pay increases due to inflation are ignored
by 46 percent of the federal plans (the Civil Service Retirement
Sj^stem provides for alternative valuations using ERISA-like assump-
tions, but inflationary salary increases are ignored in the statutory
valuation used for funding purposes) and by 59 percent of the large and
70 percent of the small state and local plans. While nearly 25 percent
of all public plans provide for automatic pension increases equal to some
fraction of the rise in the cost-of-living, it is the exception rather than
the rule for such increases to be included in the valuation assumptions
of such plans. "Static" valuations which ignore future salary and
cost-of-living increases due to inflation may easily understate true
pension costs by 50 percent or more.56
There are additional indications that the actuarial valuations for
public pension plans may be less sophisticated than for private
pension plans. For example, 11.5 percent of the largest state and
local plans and 48 percent of the smaller plans do not include a table
of employee withdrawal rates within their package of actuarial
assumptions. In like manner, 15 percent of the large plans and 39
percent of the small plans do not utilize separate rates of disability
even though such plans do provide for disability benefits.
For most public pension plans having actuarial valuations, the
actuarial value of plan assets was found to be identical with the
"book value" of system assets. The larger public plans indicated
that plan assets are usually carried at cost although the bond portfolios
in about one-third of the plans were also valued on an amortized (de-
preciated) cost basis. Surprisingly, nearly one-fifth of the locally
administered plans said that the actuarial value of plan assets was
determined on a market basis (perhaps indicating a high incidence of
cash or savings accounts among small plans).
In summary, it can be seen that plan sponsors, plan participants,
and the general public alike are kept in the dark as to a realistic
assessment of true pension costs under the vast majority of all public
employee retirement systems. The lack of actuarial valuations, the
presence of actuarial gimmickry, the use of unrealistic "static"
assumptions, and the general lack of actuarial standards all contribute
to this unfortunate state of affairs.
» See footnote 53, p. 195.
*« See footnote 53, p. 177 and p. 195.
163
CUKRENT FUNDING STATUS OF DEFINED BENEFIT PLANS
From the information shown in Table Gl it can be seen that the
level and incidence of employer contributions to public pension plans
is determined on a wide variety of methods ranging from pay-as-jou-go
to full actuarial funding. Therefore, it is not surprising to find that
current funding levels for public plans also stretch over the wide
range shown in Table G7.
As discussed in a previous section, there is currently no consensus
as to what constitutes a suitable minimum basis for determining
contributions to public pension plans. As a result, pension experts
also disagree on the level of pension assets that a plan must accumulate
in order for it to be considered "adequately" funded. This report
utilizes several different measures of funding progress against which
to test the "adequacy" of public pension plan funding.
Perhaps the most understandable basis on which to measure the
funding progress of a public pension plan would be to adopt the straight
forward notion of most laymen that a plan is "fully funded" when
current assets are sufficient to "purchase" or cover the benefits for
all those presently retired plus the benefits based on past service
for those who have not yet retired. The sum of these benefit values
might be described more technically as the actuarial present value
of accrued benefits. For private pension plans this value may be com-
puted for vested benefits only or for all accrued benefits on either an
"ongoing" plan basis or on a "termination'' basis (the termination
basis may have little relevance for public plans not expected to ter-
minate). Unfortunately it is only for the exceptional public plan that
such present values are calculated on any basis.57
PERS UNFUNDED ACCRUED LIABILITY
In the absence of a uniform measure of funding, such as the one
described above, pension fund analysts are forced to use the "unfunded
accrued liability" as the figure most readily available for comparative
purposes. The unfunded accrued liability is the difference between a
plan's accrued (actuarial) liability and plan assets. A plan having a
ratio of plan assets to accrued liability equal to 100 percent is said
to be "fully funded". Actuaries disagree as to the appropriateness of
using such values for comparative purposes.58
Notwithstanding the problems attendant with the use of plan un-
funded accrued liabilities as a measure of funding progress, it may be
instructive to analyze such figures in order to gain a sense of the
magnitude and range of plan funding for the PERS as a whole. The
data in Table G7 shows the distribution of the ratio of plan assets to
plan accrued liabilities for 70 percent of the largest federal, state,
and local plans which have had recent actuarial valuations.
The mean ratio and the median ratio of plan assets to accrued
liabilities for the state and local category are both 51 percent. For
both the federal and the largest 25 state and local plan categories the
mean ratio and median ratio are both about 58 percent. All three
57 Financial Disclosure Practices of the American Cities (Washington, D.C.: Coopers and Ly brand and the
University of Michigan, 1976), p. 30.
« Pensions and Investments, Vol. 4, No. 18, September 27, 1976, p. 16.
164
distributions appear to be fairty symmetrical with the first and third
distribution being somewhat more peaked than the second. As can
be seen, only a few plans have reached the status of being "fully
funded" as determined on their present actuarial basis. Significantly,
the largest 25 state and local plans, which cover 50 percent of the
total assets of all state and local plans, are shown to have somewhat
higher funding ratios than the remainder of the larger plans. Un-
doubtedly, this is due to the fact that all but five of the 25 largest
Elans responded that emplo}^er contributions are made on an actuarial
asis amounting to not less than normal cost plus 40 year amortization
of any unfunded accrued liability.
TABLE G7.— RATIO OF PLAN ASSETS TO ACCRUED LIABILITY FOR FEDERAL SYSTEMS AND 70 PERCENT OF
LARGE STATE AND LOCAL PUBLIC EMPLOYEE RETIREMENT SYSTEMS
[In percent of plans]
Ratio of assets to accrued liability
10 or
11 to
21 to
31 to
41 to
51 to
61 to
71 to
81 to
Over
System category
less
20
30
40
50
60
70
80
90
90
Total
Federal
4.5 .
4.5
4.5
18.2
31.8
22.7
4.5
4.5
4.5
100
State and local (70 percent of
large plans)
4.6
9.1
5.7
11.1
16.5
16.5
16.1
11.1
7.0
2.3
100
Largest 25 State and local plans
8.0
8.0
8.0
36.0
16.0
16.0
4.0
4.0
100
Before discussing the limitations connected with the data in Table
G7, some additional observations can be made on the relationship of
this first measure to other measures of funding progress. Generally it
was found that a plan with a minimum ratio (plan assets to accrued
liability) of 70 percent or more also had an above average ratio of
assets to annual benefit payments (shown later). A generalization
that was also found to be valid for all but the smallest plans is that a
plan with a ratio of 40 percent or more can be assumed to have ac-
cumulated assets sufficient to cover the actuarial present value of
benefits for all those currently receiving benefits.
The distribution of asset to accrued liability ratios for smaller plans
is not shown due to the small response rate resulting from the lack of
actuarial valuations for such plans. The mean of the distribution of
such ratio for plans with 100 to 999 active participants was significantly
lower, 35 percent, than for the largest plans while the mean for the
smallest plans, those having fewer than 100 active participants, was
only three percentage points below that of the larger plans. The mean
of 54 percent for state plans is significantly higher than the mean ratio
of 45 percent for local plans.
There is no general agreement among pension experts on the mini-
mum ratio of plan assets to accrued liability necessary in order to con-
sider a plan "adequately" funded. A factor which complicates the
derivation of an accepted minimum funding ratio is the fact that when
a plan is amended to increase benefits for past service, an unfunded
liability is created which is ordinarily amortized over a period of
years. However, for a long-established plan, a high level of unfunded
accrued liability may indicate that (a) the plan has no systematic
program of reducing its unfunded liability, (b) the plan may not even
be paying its normal cost and interest on the unfunded liability, causing
the unfunded amount to increase, or (c) unrealistic actuarial assump-
165
tions have been resulting in losses, causing the unfunded amount W
increase. Even if a generally accepted minimum funding ratio were
fixed at, for example, 50 percent, the data shown in Table G7 would
be inadequate for making a determination of the percentage of public
plans meeting such a test (53 percent of the large state and local
plans in Table G7 are shown as having a ratio of 50 percent or more) .
The reasons for the limitations of the data in Table G7 are severalfold.
First, the plans which are excluded from Table G7 because they
lack actuarial valuations are subsequently shown to be less well-funded
than the included plans. Secondly, the distribution of funding ratios
is definitely biased upward because the unfunded accrued liability for
many plans may be "frozen" at an arbitrarily low level or may be
calculated using "static" or unrealistic actuarial assumptions. This
latter problem which was discussed at length in the last section is
illustrated "by the effect on the ratio for the Civil Service Retire-
ment System. The ratio for the federal plan included in Table G7
was calculated at 25 percent using static actuarial assumptions.
The use of realistic or "dynamic" actuarial assumptions would
have reduced the ratio to 15 percent. Such a change in assump-
tions would have no effect on the ratio for the Military Retirement
System which remains at "0" because of the plan's totally unfunded
status.
Given the above information on funding ratios, it is possible to
estimate the "unfunded accrued liability" for the PERS as a whole.
As shown in Table VI of Appendix IV, the unfunded accrued liability
for all federal plans is $243 billion based on actuarial valuations per-
formed in 1972-76. It is estimated that the figure would be in the range
of $425 billion if "dynamic" actuarial assumptions were used instead
of "static" ones.
For all state and local public pension plans the average ratio of plan
assets to accrued liability is estimated to be 45-50 percent based on
the actuarial information for plan's having recent valuations. There-
fore, if for 1975 the total actuarial value of assets is taken to be $100
billion for all defined benefit plans, the total unfunded accrued liability
for such plans is between $100 and $120 billion. This estimate is con-
sistent with other data showing that the overall ratio of unfunded
accrued liability to covered payroll is in the neighborhood of 100
percent.
The use of static actuarial assumptions by many plans causes the
above estimate to be unrealistically low, however. For the federal Civil
Service Retirement System the accrued liability based on dynamic assump-
tions was 70 percent greater than under static assumptions. The under-
statement for state and local plans is less, probably in the range of
-20-30 percent, considering the fact that some plans use dynamic
assumptions. Therefore it is estimated that a valuation of all state
and local pension plans on dynamic assumptions would reveal a total
unfunded accrued liability of between $150 and $175 billion for 1975.
The above estimate varies significantly from the $270 billion
estimate of the 1975 unfunded accrued liability for state and local
plans presented in a recent paper, "Funding Public Pensions: Civil
Service, State-Local, Military", by Alicia H. Munnell and Ann M.
Connolly.59 The wide variation in estimates of the unfunded accrued
69 Alicia H. Munnell and Ann M. Connolly, "Funding Public Pensions: Civil Service, State-Local, Mili-
tary," presented at Federal Reserve Bank of Boston Conference, October 6, 1976.
166
liability for particular plans and the PERS as a whole serves as a
graphic reminder of the sensitivity of such figures to actuarial assump-
tions and methodology. In the absence of universally applicable
actuarial standards or guidelines it is clear that the mere disclosure of
plan unfunded accrued liabilities may produce unreliable or even
misleading comparisons of the funding status of different public em-
ployee retirement s}^stems.
"QUICK LIABILITY" AS A MEASURE OF PERS FUNDING
Because of the inadequacy of the measures discussed in the last
section when plans use different actuarial valuation methods and
assumptions, some pension authorities have used a measurement
termed the Benefit Securit}^ Ratio or BSR.60 The BSR is the ratio of
the value of plan assets to the actuarial present value of all accrued
pension benefits.
The actuarial present value of accrued pension benefits can be
thought of as consisting of three values — (1) the actuarial present
value of future benefits for those persons already receiving benefits
(sometimes referred to as the "retired life reserve"), (2) the accumu-
lated value of contributions for present active members, and (3) the
actuarial present value of benefits attributable to past service for all
members not yet receiving benefits less the value of such benefits
attributable to emplo3ree contributions (i.e. the amount in (2)). The
third value is usually not available for public plans; therefore the
BSR is sometimes reduced to the ratio of plan assets to the sum of
(1) plus (2). This latter ratio has been termed the Quick Liability
Ratio (QLR).61 A QLR of exactly 100 percent means that the plan
assets are sufficient to continue paying benefits to those already re-
tired and to refund employee contributions for active employees,
with nothing left over to fund employer-provided pensions for active
employees. A plan using the "terminal" method of funding would
always display a QLR of 100 percent (assuming all actuarial assump-
tions are realized).
For purposes of this report the asset value used in the numerator
of the QLR is the actuarially computed value of plan assets. For most
public plans this value is identical to the book value of plan assets.
For the majority of the plans responding, the actuarial value of plan
assets was found to be within 5 percent of market value. For about 17
percent of the plans the market value of plan assets was less than 90
percent of the actuarial value.
It was assumed that the values in the numerator and the denomina-
tor of the QLR were computed on a consistent basis. In other words,
it was presumed that the interest rate used by the actuary in com-
puting the "retired life reserve" was determined in a manner con-
sistent with the method used to value plan assets. The QLR's are
overstated for those plans which exclude from the retired life reserve
the actuarial present value of future cost-of-living increases.
Some actuaries have expressed the opinion that the QLR should
never be less than 100 percent.62 The QLR for 60 percent of the large
*° Frank L. Griffin and Charts L. Trowbridge, Status of Funding Under Private Pension Plant (Home-
ward, Illinois: Richard D. Irwin, Inc., 1969), p. 4.
See footnote 30, p. 17.
M See footnote 27.
167
state and local plans for which actuarial data was available is shown
in Table G8. About 28 percent of the large plans and 36 percent of the
25 largest plans fail this minimum test of funding adequacy. As will be
shown later the remaining 40 percent of the large plans are consider-
ably less well-funded than the ones included in Table G8.
Based on the measures of funding progress the following percentages
of state and local plans were estimated to fall short of a QLR of 100
percent — large plans, 39 percent; medium sized plans, 50 percent;
small plans, 38 percent; and total plans, 40 percent. The QLR for the
federal Military Retirement System is 0 percent due to its totally
unfunded status. The federal Civil Service Retirement System, like
40 percent of the large state and local plans, was unable to supply the
accumulated value of contributions for active members. The QLR
for the Civil Service Retirement System is about 36 percent if it is
assumed that the accumulated value of member contributions is $20
billion as of June 1972.
TABLE G8— QUICK LIABILITY RATIOS FOR STATE AND LOCAL PUBLIC EMPLOYEE RETIREMENT SYSTEMS
[In percent!
Percent of defined benefit plans
Less than
State and local system category 100 100 to 149 150 to 199 200 or over Total
60 percent of large plans 28 45 20 7 100
25 largest plans. 36 44 20 100
Estimates for —
Large plans (over 1,000 active members).. 39
Medium plans (100 tc 993 active members) 50
Small plans (less than 100 members). 38
Total plans 40
It should be noted that the QLR is not a particularly good or
informative measure of the funding status of very small plans or
relatively new plans that may have few retired persons. A small
contributory plan being maintained on a pay-as-}rou-go basis will
show a QLR of 100 percent until benefits become payable to the
first retiree, at which time the ratio may decline precipitously below
100 percent. In the extreme, the plan for a one person police depart-
ment may show a constant ratio of 100 percent over a period of
years until the first policeman retires at which time the employer
contributions may jump from 0 percent to 50 percent of payroll
and the QLR ma}^ fall to 15 percent. Therefore, because just 40
percent of the small plans with less than 100 members have a QLR
of less than 100 percent does not necessarily imply that the remaining
60 percent have been or are currently being funded at actuarially
adequate levels.
It should also be understood that a QLR of less than 100 percent
for a particular plan may be due to the newness of the plan or to-
recent sizable benefit increases. A new plan may grant substantial
benefits to employees (particularly to those at or near retirement)
based on service rendered prior to the plan's establishment. There-
fore, even if such a plan is actuarially funded, the QLR may be less
than 100 percent for a period of time until the retired life portion
of the unfunded accrued liability has been amortized. Except for
168
the ve^ small plans, one-third of which were established or re-
structured after 1965, plan age was not found to be a highly signi-
ficant factor in explaining the relatively large percentage of plans
failing to accumulate assets sufficient to cover the quick liability.
The plan age factor is discussed in more detail in the next section.
RESERVE RATIO AS A MEASURE OF PERS FUNDING
Because of the large percentage of plans unable to supply infor-
mation on accumulated employee contributions, the most extensive
analysis of public pension plan funding was performed using an abbre-
viation of the QLR which might be termed the " Reserve Ratio" or
RR. The RR is the ratio of plan assets to the actuarial present value
of future benefits for those already receiving benefits under a plan.
The RR is a less adequate measure of plan funding than the QLR;
yet, as Table G9 shows, nearly one-third of all public pension plans
have failed to accumulate assets sufficient to achieve a reserve ratio
of 100 percent. About 23 percent of all large state and local plans,
42 percent of the medium sized plans, and 31 percent of the small
plans fail to meet the RR test. The RR for the federal Civil Service
Retirement System is 49 percent.
TABLE G9. — RATIO OF RETIREMENT SYSTEM ASSETS TO ACTUARIAL PRESENT VALUE OF BENEFITS FOR
CURRENT RECIPIENTS
Ratio of assets to reserve (percent)
Plans with
reserve
Less than equal to
System category 100 100 to 149 150 to 199 Over 200 zero* Total
State and local government:
L By level of administration:
A. State administration...
B. Local administration...
II. State and local totals by sys-
tem coverage type:
A. State and local gov-
ernment
B. Police and fire
C. Teachers (including
higher education)...
Percent of plans with an actuarial valuation i
(about 45 percent of all plans)
n 1972 or later
15.0
14.5
31.8
38.5
100
25.9
15.3
5.9
32.4
20.5
100
20.4
7.9
17.2
48.7
5.7
100
27.1
17.9
4.1
26.5
24.4
100
15.0
22.5
25.0
37.5 .
100
Tota! 24.9 15.2 8.2 33.0 18.7 100
Percent of Total Plans in Category
Estimated for all plans:
III. By size of system:
A. Large. 23
B. Medium 42
C. Small 31
Total 32 ...
I Small plans with no current benefit recipients or with paid-up annuities for retireesi
Note: Data relates to table 56 in app. I.
As stated earlier, except for small plans, the lesser age of a plan was
not found to be a particularly significant factor contributing to the
larger percentage of plans failing the QLR and RR tests. Contrary
to what might be expected, newer plans are more likely to meet the
169
minimum funding tests even though they have had a shorter period
of time over which to fund. Of the 23 percent of the larger plans failing
the RR test only 4.3 percent is attributable to those plans established
in the past 20 years while the remaining 18.7 percent is attributable
to those plans established earlier. The probability of a large plan having
a Reserve Ratio of less than 100 percent was found to be 16 percent
for the group of plans established after 1955 as well as for those plans
established between 1941 and 1955. In contrast the probability of
failing the RR test was found to be 38 percent for the large plans
established before 1941.
A similar situation applies to those plans having 100 to 999 active
members. In this case plans established after 1955 were found to have
a probability equal to 16 percent of failing the RR test. The corre-
sponding probability for plans formed prior to 1956 is 64 percent.
Only 15 percent of the total number of plans in the medium strata
having an RR of less than 100 percent were established after 1955.
For small plans having fewer than 100 active members, the post-
1955 probability of failing the RR test is 27 percent while the pre-1956
probability is 37 percent. The plans established in the past 20 years
were found to comprise 56 percent of the total number of small plans
failing the RR test.
Just as pension plan underfunding was found to be more likely for
older plans than for newer plans, Table G9 shows that the proportion
of plans failing the Reserve Ratio test is larger for locally adminis-
tered plans, 26 percent, than for state administered plans, 15 percent.
Of special note is the finding that only two plans among the 25 largest
state and local plans failed to meet the RR test. The distribution of
Reserve Ratios by system coverage type shows that police and fire
plans have the highest probability of failing the RR test, 27 percent,
while teacher plans have the lowest, 15 percent. Considerably more
detail on plan fimding status by size of plan and coverage type is
given in Table 56 of Appendix I.
The question might be asked as to why the older plans, particularly
at the local level, tend to have a higher probability of being under-
funded. The answer is severalfold. First, such plans tend to be financed
on a pay-as-you-go or other non-actuarial method, thus diminishing
the level of assets factored into the numerator of the Reserve Ratio.
Second, the benefit levels for such plans tend to be higher than average.
Third, such plans tend to be more generous than others in granting
post-retirement benefit increases related to rises in the cost-of-living
or to rises in the levels of active duty pay. Together these last two
items inflate the value of benefits in the denominator of the Reserve
Ratio. For example, because cost-of-living increases are usually not
advance funded under such plans, the Reserve Ratio automatically
decreases by "X" percent every time an "X" percent cost-of-living
increase is granted. One pension authority summed up this situation
well by saying that "funding is in fact poorest where it is most
needed." 63
It should be noted that the distribution of Reserve Ratio's in
Table G9 by level of administration and coverage type includes only
those plans having recent actuarial valuations and for which actuarial
« See footnote 9, p. 171. ' ■ . ■ '
170
data was supplied. This first group of plans (Group 1) includes about
74 percent of the large state and local plans, about 65 percent of the
plans in the medium strata, and about 39 percent of the smaller plans
for a total of 45 percent overall. An analysis of the lesser funding
status of the excluded groups is presented in the next section.
ASSETS TO BENEFIT PAYMENTS RATIO AS A MEASURE OF PERS FUNDING
Another measure of the funding status of public pension plans that
is often used when comparable actuarial values are lacking is the
ratio of plan assets to the total annual benefit pa}'ments under a plan
(ABPR). For large plans the ABPR shows a high positive correlation
with such measures as the Quick Liability Ratio and the Reserve
Ratio. Some care is needed in interpreting this measure as it applies to
smaller plans, however, as discussed later.
Some have suggested that public pension plans maintain a level of
assets equal to 10 or 15 times current benefit payments in order to be
considered minimally funded.64 A pension plan maintaining assets
sufficient to keep the ABPR at a level of 10 or greater can usually be
expected to also meet the Reserve Ratio test at 100 percent. From
Table G10 it can be seen that 33 percent of all state and local plans
currently fail to meet an ABPR test set just over 10. About 28 percent
of the larger state and local plans currently display an ABPR of 10 or
less. Significantly, only two of the 25 largest state and local plans,
comprising 50 percent of the asset and participant universe, were
found to have a ratio of 10 or less.
TABLE G10.— RATIO OF SYSTEM ASSETS TO BENEFIT PAYMENTS FOR DIFFERENT GROUPS OF STATE AND LOCAL
PUBLIC EMPLOYEE RETIREMENT SYSTEMS
[Cumulative percent of defined benefit plans]
Ratio of the book value of system assets to total annual benefit payments
Otol 2 to 5 6 to 10 11 to 15 16 to 20 21 to 25 26 to 30 31 to 35 Over 35
System category
State and local totals:
A. Group 1 — Plans with a reserve
ratio and having an actuarial
valuation in 1972 or later 2.3 16.3 28.2 41.0 56.8 64.8 70.1 74.5 100
B. Group 2— Plans without a reserve
ratio and having an actuarial
valuation in 1972 or later 13.7 33.0 35.1 35.9 48.7 49.3 50.3 50.5 100
C. Group 3— All other plans not
having recent actuarial valua-
tions 21.8 32.9 41.7 46.4 51.0 55.5 59.3 59.3 100
Total 9.5 23.5 33.0 41.7 53.9 59.8 64.0 66.5 100
Note: Data relates to table 57 in app. I,
Given the fact that total benefit payments for all state and local
plans have been increasing at an average annual rate of about 15%,
an asset to current benefit payments ratio of 10 is equivalent to about
6 or 7 years of expected future benefit payments. For state and local
plans as a whole the ABPR is equal to 14.9 (see Table Fl). This ratio
is equivalent to about 8-9 years of the expected future benefit pay-
ments for the state and local plan universe. The ABPR for the
federal Civil Service Retirement S3'stem was found to be 5.3 or equiva-
" See footnote 28.
171
lent to less than five years of future benefit payments. The APBR is
2.9 for all federal plans combined.
The overall ratio of plan assets at book value to annual benefit
payments by size of system and coverage category is given in Table
Pi. The ABPR is 15.4 for large state and local plans, 8.3 for medium
sized plans, and 10.9 for small plans. Part of this variation is explained
by the fact that smaller plans have on the average been established
much more recently than larger plans, and thus have had a shorter
period of time in which to build up assets. However, on the whole, the
lower ratio for smaller plans is explained by the larger proportion of
such plans using non-actuarial funding methods.
For this same reason, the overall ABPR for state-run plans, 16.3,
was found to be significantly higher than the ratio for locally admin-
istered plans, 11.8. The greater use of actuarial funding methods by
state administered plans also explains the larger funding ratios for
the state-run plans covering local government employees. In the
police and fire category, the ABPR is 21.5 for state administered plans
and only 8.6 for locally administered plans. A similar contrast in
funding ratios for state vs. local administration was also found to
apply to those plans covering teachers and other local government
employees.
The ratio of plan assets to total annual benefit payments (ABPR)
has proved useful in evaluating the current funding status for that
group of plans lacking actuarial data and thus making the calculation
of the Quick Liability Ratio and the Reserve Ratio impossible. The
plans included in Table G9 for which Reserve Ratios were computed
are shown in Table GlO as Group 1 (making up about 45 percent of
all plans). The plans excluded from Table G9 and included in Table
GlO are designated Group 2 (about 22 percent of all plans) and
Group 3 (about 33 percent of all plans). From Table GlO it can be
seen that the Group 1 plans having recent actuarial valuations are
generally much better funded than are the plans in the other two
groups.
Nearly 22 percent of the Group 3 plans, those not having recent
actuarial valuations, have an asset to benefit payments ratio of 'TV'
or less while only 2.3 percent of the Group 1 plans are this poorly
funded. For Group 1 plans, a comparison of Table G9 and Table GlO
shows that the percentage of plans, 25 percent, with an RR of less
than 100 percent is roughly equivalent to the percentage of plans with
an ABPR of 10 or less, 28 percent. By way of analogy, about 35
percent of the Group 2 plans and 42 percent of the Group 3 plans can
be expected to fail the RR test.
The variations in the distribution of current funding ratios for
Groups 1, 2, and 3 were generally found to comport with the differ-
ences in the funding methods used by the three different groups.
Table Gil shows that 20.8 percent of the Group 1 plans are funded on
a non-actuarial basis while 33.4 percent of the Group 2 plans and
79.3 percent of the Group 3 plans are non-actuarially funded. Nearly
61 percent of the Group 1 plans responded as having a funding basis
equal to or exceeding normal cost plus 40 year amortization of any
unfunded accrued liability while only 10.5 percent of the Group 3
plans indicated actuarial funding at this level. A comparison of the
information in Tables GlO and Gil shows a close correlation between
74-365—78 12
172
the percentage of plans which are actuarially funded and the percent-
age of plans with funding ratios above the overall average ABPR
of 15.
TABLE Gil. — METHODS OF FUNDING USED BY DIFFERENT GROUPS OF PUBLIC EMPLOYEE
RETIREMENT SYSTEMS
[Percent of defined benefit plans]
Nonactuarial basis Actuarial basis
Payment
Normal cost less than
paid and normal cost
Normal unfunded and 40-yr
cost paid accrued amortiza-
and no liability tion of
unfunded amortized unfunded
accrued over 40 yrs accrued Un-
liability or less liability known Total
Ter- Employer
minal matching
Pay-as- fund- other non-
System category you-go ing actuarial
State and local totals:
A. Group 1— Plans with a
reserve ratio and hav-
ing an actuarial valua-
tion in 1972 or later. ... 12.8 .1 7.3 20.1 40.9 13.9 4.4 100
B. Group 2— Plans without a
reserve ratio and hav-
ing an actuarial valua-
tion in 1972 or later 20.0 13.4 24.4 32.6 .5 9.1 100
C. Group 3— All other plans
net having recent actu-
arial valuations 21.8 .5 57.0 7.8 2.7 4.0 6.1 100
Total 17.0 .2 24.7 17.4 26.8 7.7 6. 1 100
Note: Data relates to table 58 in app. I.
It might be noted that in Table GlO nearly half of all the plans in
Groups 2 and 3 are shown as having ABPR's of over 35. The reason
for this seeming disparity is that over 96% of the Group 2 and Group
3 plans are small with a large percentage of such plans being more
newly formed and having either no currrent benefit recipients or hav-
ing very small benefit payments (which may amount to no more than
the return of contributions to a few terminated employees). A similar
phenomenon occurs in Table G9 where 18.7% of the plans (all being
smaller plans) are shown as having no "reserve" (present value of
benefits for current retirees, survivor annuitants, etc.). In addition to
including plans with no current benefit recipients, this category in
Table G9 includes plans (many of them fully insured) for which some
portion of plans assets have been transferred to an insurance company
to purchase paid-up annuities.
Comparison of Public and Private Pension Systems
A perspective of the overall funding progress of the PERS, and
how it relates to the funding of the private pension system, can be
obtained from the information shown in Table Gl2. As can be seen,
the overall ABPR for state and local retirement systems improved as
many plans moved away from pay-as-you-go financing and adopted
actuarial funding until a peak ratio of 19.3 was reached in 1960. After
1960 the ratio of assets to benefit payments steadily decreased to the
14.9 level shown for 1975.
173
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From 1970 to 1975 the ABPR for all State and local plans plunged
over 18 percent. The forces causing this decline were apparently also
present in the private pension system which experienced a similar
23 percent 5-year decline from the 1970 ABPR of 18.6 (which in
that year was identical to the ratio for the PERS). Over this recent
5-year period total public plan assets increased 83 percent while
total benefit payments jumped 124 percent; the corresponding in-
creases for the private pension system were 55 percent and 101 per-
cent, respectively.
Several factors explain the more rapid increase in benefits over
assets. For public plans the average benefit per recipient increased
67 percent while the number of recipients increased 34 percent. For
private plans average benefits per recipient increased 36 percent while
the number of recipients increased 48 percent. For both public and
private plans, the number of benefit recipients grew substantially
faster than the number of active participants (which increased 30
percent and 15 percent respectively), thus reflecting the increased "ma-
turity" of both systems. For example, the ratio of benefit recipients
to active participants for the private pension S37stem jumped from
18 percent in 1970 to 23 percent in 1975. This rise may have been
accelerated by the trend to earlier retirement in this period, which
was made more attractive by early retirement benefit liberalizations.65
Undoubtedly a significant portion of the marked increase in the
average benefits per recipient between 1970 and 1975 was due to
the upward pressure on benefits and wages inspired by the sharpest
rate of inflation to prevail since World War II. The more rapid
increase for public plans, 67 percent, over private plans, 34 percent,
is partially due to the fact that over 90 percent of all public employee
pensions are based on average compensation paid within the last
1 to 5 years prior to retirement (see Chapter E for detail on public
pension benefit formulas) . Probably fewer than one-half of the persons
retiring under private plans in this period had their pension based on
final average compensation. A second factor contributing to the more
rapid rise in average benefits under public plans over those under
private plans is that 95 percent of all public employees are covered
under plans which adjust retiree pension benefits either automatically
or on an ad hoc basis to take into account rises in the cost-of-living.
Probably less than a majority of the retirees under private plans had
their pensions similarly adjusted during the 1970-75 period (such
increases for the most part taking place on an ad hoc basis since few
plans contain automatic adjustments).
Another factor which has probably contributed to the recent down-
ward trend of the overall asset to benefit payment ratio, at least for
public plans, is the "softening" of funding policies of systems that
once followed more rigorous contribution schedules.66 Undoubtedly
the actions of some employers to hold down contribution levels by
means of altering actuarial assumptions and methods was brought
about in the same inflationary atmosphere which also led to the
greatly increased benefit payments during that period. As mentioned
previously the actual contributions for over 15 percent of the largest
state and local plans were found to be less than 80 percent of the
*5 Bankers Trust Company, 1975 Study of Corporate Pension Plans (New York, 1975).
66 See footnote 9, 172.
176
contributions required under the actuarial funding methods used for
such plans.
Over the period 1970 to 1975 the funding progress of the public
pension system nearly parallels that of the private pension system as
a whole. The question might be asked as to whether the 1975 ABPK
of 14.9 for the public system and the 1975 ABPR of 14.4 for the private
system means that the funded position is nearly identical for both
systems. This is undoubtedly not the case since the overall ABPR
reveals nothing about the distribution of plan funding levels and does
not take into account significant differences in the benefit structures
and other plan and participant characteristics of the two systems.
There are several factors which would lead one to believe that the
private system is better funded than the public system for any given
ratio of assets to benefit payments. First, the level of assets necessary
to meet future benefit payments is highly dependent on the present
ages of the benefit recipients. On the whole it can be expected that the
average age of those receiving private pension benefits is significantly
greater than the age of those receiving public pensions. This is a direct
consequence of the much earlier "normal retirement age" under public
plans, usually between ages 50 and 60, than under private plans,
usually age 65. Therefore, based on this one factor alone it might be
conjectured that in 1975 the private system as a whole ma}^ exhibit a
funding ratio 20 percent to 30 percent higher than the public system
if the nearly identical ABPR ratios of the two systems were to be
translated into an actuarially derived ratio, such as the Reserve Ratio
discussed earlier.
Another factor which tends to diminish the usefulness of the ABPR
as a comparative measure of the funding progress of the private and
public systems is that the ABPR does not take into account future
automatic post-retirement cost-of-living increases as an actuarial
measure would, e.g. the Reserve Ratio. Since the majority of the
retirees under public plans and an insignificant number of the retirees
under private plans enjoy automatic post-retirement benefit adjust-
ments, an actuarially derived funding ratio for the private pension
system, such as the Reserve Ratio, might be expected to be 10 percent
to 20 percent higher than the public system ratio, even though the two
systems have identical ABPR's.
A glimpse of the distribution of funding ratios for private pension
plans as it appeared in 1966 is given in Table G13. The information
taken from the Griffin-Trowbridge study cited in Table G13 was based
on a 50 percent subsample of private plans representing about 25
percent of the private pension universe at that time (excluding plans
with fewer than 25 participants and plans financed on a pay-as-you-go
basis which covered less than 3 percent of all participants).
The overall Reserve Ratio for the private pension system can be
seen to be 3.76 for 1966. The Reserve Ratio is 1.72 for the 25 largest
state and local plans in 1975 (such plans comprise 50 percent of the
PERS asset and part icipant universe). Even if the Reserve Ratio
(RR) for the private system were to decrease from 1966 to 1975 by
the same percentage as the ABPR decreased over this period, about
40 percent, the resulting RR of the private pension system, 2.3,
would still be at least 30 percent greater than the RR for the public
system as a whole. This finding is consi tent with the results expected
from the general reasoning presented earlier.'
177
Another means of comparing the public and private systems is to
utilize the relationship that a given plan's Quick Liability Ratio
(QLR) is with rare exception (mainly contributory plans with no
vesting of employee contributions) less than the Vested Benefit
Security Ratio (the VBSR is the ratio of plan assets to the actuarial
present value of vested accrued benefits). Table Gl3 shows that in
1966 23 percent of the private pension plans failed to meet the VBSR
test of 100 percent. This compares with the estimated 40 percent of
all state and local plans in 1975 which failed to meet the QLR test of
100 percent. With minor exception the private plans failing to meet
the VBSR test had an effective period of past funding of less than 20
years (i.e. the plan was not yet 20 years old at the time of the study or
had a significant benefit increase within ten years prior to the study).
In contrast, less than one-fourth of the public pension plans failing
the QLR test were established or restructured within the last 20 years.
Of special note in this regard is the fact that 36 percent of the 25
largest state and local plans failed the QLR test after plan age was
taken into account. At the other end of the funding spectrum, Table
Gl3 shows 37.6 percent of the private pension plans as having a
VBSR of 160 percent or more. Only two of the 25 largest state and
local plans, or 8 percent, were found to have a QLR of 160 percent or
greater in 1975. Table Gl3 also shows 54.2 percent of the private
plans as having assets sufficient to cover 100 percent of the actuarial
present value of all accrued benefits (i.e. plans with a BSR of 100
percent or more). Only one of the 25 largest state and local plans is
estimated to be "fully funded" according to the BSR measure.
TABLE G13.— FUNDING RATIOS FOR PRIVATE PENSION SYSTEMS, 1966
Percent of plans
Ratio (percent)
Vested benefit
security ratio
(VBSR)
Benefit
securitv ratio
(BSS)
Reserve ratio
m
Less than 40
40 to 59
60 to 79
80 to 99 ...
100 to 119
L 1
3. 6
8.1
10.2
11.9
3.9
8.7
15.1
18.1
20.4
c)
o
o
(0
c)
120 to 139
140 to 159
160 or more . .
17.0
10. 5
37. 6
24.7
5.3
3.8
0)
0)
(0
Total
__■ 100
100.0
0)
Overall ratio for entire system
1.23
1.0
3.76
1 Not available.
Source: Frank L. Griffin and Charles L. Trowbridge, "Status of Funding Under Private Pension Plans" (Homewood,
III.: Richard D. Irwin, Inc., 1969).
From the above analysis for the period ending in 1975, just prior to
the effective date of ERISA funding standards for private plans, it
can be concluded that the status of private pension plan funding for
the system as a whole had progressed considerably beyond the funded
status of the public emplo^'ee retirement system. Generally it can be
expected that the vast majority of the private plans failing to meet a
funding test such as the QLR, RR, or VBSR do so because of their
more recent adoption, usually being within the past 15 or 20 years. For
public plans the opposite holds — i.e., the older plans are more likely
178
to be underfunded. The percentage of public plans that fail any given
funding test can be expected to be significantly greater than the
corresponding percentage of private plans. On the other end of the
funding distribution it can be expected that a near majority of private
pension plans are "fully funded" using the BSR as a measure while
less than 25 percent of all public systems are as adequately funded.
A final perspective on public pension plan funding might be gained
from a comparison of several characteristics of public plans with those
of collectively-bargained multiemployer plans in the private system.
The Grimn-Trowbridge study showed the average BSR and VBSR
to be about 30 percent less for collectively-bargained multiemployer
plans as compared with the averages for the universe of private plans.67
From Table Gl4 it can be seen that in many ways the characteristics
of large state and local pension plans parallel those of multiemployer
pension plans. A more detailed study based on actuarially derived
funding ratios may very well reveal a closer correlation between the
funding distributions of public pension plans and multiemployer plans
than between the public plan and non-multiemployer plan distributions.
TABLE G14.— DISTRIBUTION OF PRIVATE PENSION PLANS AND STATE AND LOCAL GOVERNMENT PENSION
PLANS BY SELECTED PLAN CHARACTERISTICS, 1975
Percent of defined benefit plans
Private pension plans
Single and
State and Multiem- multiem-
loca! plans ployer plans ployer plans
Size of plan:
Large (1,000 or more active participants) 7. 8 i (96. 3) 43. 2 i (94. 9) 4. 6 i (81. 6)
IVedium (100 to 999 active participants) 13.8 (2.2) 46.4 (5.0) 15.2 (14.2)
Small (less than 100 active participants) 78.4 (1.5) 10.4 (.1) 80.2 (4.2)
Total
Approximate number of plans.
II. Ratio of retired and terminated vested participants to total partici-
pants (percent) (large plans only):
Less than 25
25 to 49 __
50 to 74
75 to 100
Total
Average ratio.
HI. Ratio of plan assets to total annual benefit payments (ABPR) (large
plans only):
Less than 5 years
5 to 10 years
1G to 15 years
15 years or greater
Total
Average ratio
IV. Ratio of net cash flow to plan assets (percent) (large plans only):
Less than 10
10 to 19
20 to 29
30 or greater
Total
Average ratio.
100.0 (100.0) 100.0 (100. C) 100.0 (100.0)
4, 500
2,000
97, 000
. 10,100,000
7,700.000
33,000, 000
78.7
21.0
.3
80.5
15.8
2.8
.9
100.0
19.7
10G.0
16.7 .
12.5
10.2
15.5
20.3
51.7
21.3
16.3
52.2 .
100.0
19.0
100.0
23.6 i
23.5
63.3
11.2
2.0
26.4
42.4
22.1
9.1 .
1C0.O
13.5
1 Percent of employees.
Source of private pension data: Pension Benefit Guaranty Corp,
47 See footnote 60, p. 56.
179
SUMMARY AND CONCLUSIONS
1. Actuaries, actuarial valuations and assumptions
Unfunded public pension plans have been referred to as "financial
time-bombs".68 The cause of this situation is clear:
Plans [are] launched without knowledge of ultimate cost. Neither at establish-
ment nor on the occasion of subsequent elaboration of the pension plans have cost
calculations been made by qualified actuaries. The increase for a great number of
years of the annually maturing claims of a pension system at a more rapid pace
than the annual payroll expenditures of the corresponding active force has not
been appreciated.69
Incredibly, this early warning made in 1916 by the New York
City Commission on Pensions still goes unheeded by the major-
ity of the public employee retirement systems today.
A realistic assessment of pension costs is unknown for the vast
majority of public employee retirement systems. One-third of the
total public pension plans at all levels of government did not have
actuarial valuations in the five year period ending in 1975. This
figure would have been dramatically higher had it not been for the
recent steps taken by two states (having nearly one-fourth of all
plans) to require actuarial valuations for the plans within their juris-
dictions. Most of the plans lacking actuarial valuations were financed
on a pay-as-you-go or other non-actuarial basis.
A considerable degree of pension cost blindness was also exhibited
among the two-thirds of the public plans basing contribution rates
at least in part on actuarial funding methods. Almost 75 percent of
such plans understate current pension costs and unfunded accrued
liabilities by ignoring 1) the value of future automatic cost-of-living
increases to retirees, or 2) the value of benefit increases related to
future earnings increases.
The use of unrealistic actuarial assumptions by public pension
plans and their actuaries is an outgrowth of the lack of actuarial
standards applicable to public plans. There is presently no require-
ment that actuarial assumptions and methods be reasonably related
to the experience of public pension plans. Under these circumstances,
even if actuarially computed values are disclosed, there is no assurance
that such values can be used as meaningful comparative measures
of the funding progress of public pension plans. The evidence suggests
that few governmental units voluntarily disclose such figures anyway
(e.g. in accord with the voluntary disclosure suggested in the Munici-
pal Finance Officers Association guide "Governmental Accounting,
Auditing and Financial Reporting").70
There is a compelling need for public pension plan actuarial valua-
tions and for uniform actuarial measures and standards to enable
plan participants, plan sponsors, and taxpayers to assess the present
funding status and future funding needs of their systems.
2. Present funding practices
Over 42 percent of the federal, state, and local pension plans are
funded on a non-actuarial basis (17 percent are pay-as-you-go).
Actuarial valuations are usually not made for these plans, thus
« See footnote 28.
« See footnote 29, p. 76.
70 See footnote 57.
180
public officials are unlikely to know the progression of pension costs
under such plans.
On the other hand, it is estimated that 20 to 25 percent of all
public plans currently meet ERISA-like funding standards. These
same plans also exhibited the greatest level of past funding prog-
ress (under the several funding measures used in the study). How-
ever, there is strong evidence to indicate that over the past decade
the funding levels have been dropping for the more well-funded plans
even as other plans have been converted from pay-as-you-go to
reserve funding.
3. Current funding status
Because of inadequate actuarial assumptions, the actuarial values
supplied the Pension Task Force were understated for many plans.
Using the understated values, it was conservatively estimated that
40% of the total federal, state and local pension systems (including the
federal Civil Service Retirement System, the Military Retirement
System, and the Judicial Systems) fail to meet the funding test which
many pension experts consider a bare minimum. This test requires
pension plan assets to be sufficient to 1) return accumulated member
contributions to all active employees, and 2) continue paying benefits
to those persons already retired.
The relative burden of past underfunding varies over a wide range.
For the state and local plans supplying actuarial data (usually the
more well-funded plans), the ratio of unfunded accrued liability to
current active payroll ranged from 0 percent to over 800 percent of
payroll. This ratio was found to be less than 150 percent of payroll for
all of the 25 largest state plans (these plans cover 50 percent of all
state and local system assets and participants). For the federal systems,
the estimated ratios based on realistic actuarial assumptions are — 516
percent for the Civil Service Retirement System and 1600 percent for
the Military Retirement System. The results of a recent study by one
state of its plans (covering nearly one-fourth of all state and local
plans) reflects the funding status of the universe of municipal pension
plans. This study characterized the funding status of the pension plans
in only four of 30 cities in that state (with plan ratios of 150 percent of
payroll or less) to be "adequate".71 The funding status of the plans in
ten cities was described as "very critical" where the unfunded ac-
crued liability was 380 percent of payroll or more. The plans in the
remaining 16 cities were described as having "critical" or "serious"
funding problems.
The public pension plans (both large and small) with the most severe
funding problems tend to be older (many were established before
1941), to have above average benefit levels, and to be more heavily
concentrated at the local level of government. As to benefit levels, the
quarter of the plans paying the lowest benefits have an overall funding
ratio (assets to accrued liability) which is 45 percent greater than that
for the quarter of the plans paying the highest benefits.
4- The need for reserve funding
In the face of the climbing unfunded accrued liabilities of the public
employee retirement system, amounting to about $150-$ 175 billion
for state and local plans and $425 billion for federal plans, it would
« See footnote 30.
181
seem to be sheer folly for individual plans and the PERS collectively to
continue to ignore the true level of pension costs by foregoing actuarial
valuations, by recognizing pension costs only as benefits become pay-
able, and by resorting to actuarial gimmickry in order to reduce con-
tribution levels. Sound arguments are made in favor of reserve funding
for public pension plans that serve to discredit pay-as-you-go-pension
financing methods.
Recent events underscore the fact that governmental permanence
does not guarantee program solvency. Indeed, the ability of govern-
ments to raise revenues in order to meet the rising costs of pension
or other programs is limited by the ability and willingness of the
citizens to pay. The recent recommendations made by the United
States General Accounting Office have applicability to state and
local as well as federal pension programs for public employees:
Funding of federal retirement systems remains a serious, growing problem
that needs further attention. We believe that retirement costs for all systems
should be determined and funded on a dynamic basis. The Congress, employees,
and the taxpayers should not be misled by unrealistic estimates of retirement
costs. When the full costs are not recognized there may be a tendency to adopt
added benefits which could jeopardize the eventual affordability of the retire-
ment systems. Lack of full cost recognition also results in the understatement
of the cost of Government programs, including subsidies to agencies whose
operations are intended to be self-supporting. Furthermore, without full funding,
the Government's retirement system liabilities are not totally reflected in the
public debt.
We recommend that the Congress enact legislation requiring all federal retire-
ment systems to be funded on a dynamic normal cost basis and that the difference
between dynamic normal cost and emplo}'ee contributions be charged to agency
operations.72
72. See footnote 8, p. 15.
Chapter H — PERS Fiduciary and Investment Practices
It has long been established, both in law and society generally, that
a person who occupies a position of trust and confidence with respect
to another must act fairly, honestly, candidly, and with scrupulous
good intentions while occupying that position of trust. The standard
was articulated 50 years ago by New York Court of Appeals Chief
Judge Cardozo:
Many forms of conduct permissible in a workaday world for those acting at
arm's length are forbidden to those bound by fiduciary ties. A trustee is held to
something stricter than the morals of the market place. Not honesty alone, but
the punctilio of an honor the most sensitive, is then the standard of behavior. As
to this there has developed a tradition that is unbending and inveterate. Uncom-
promising rigidity has been the attitude of courts of equity when petitioned to
undermine the rule of undivided loyalty by the "disintegrating erosion" of par-
ticular exceptions. . . . Only thus has the level of conduct for fiduciaries been
kept at a level higher than that trodden by the crowd.1
That those who administer governmental pension systems occupy
such a position of trust and confidence with regard to the participants
and beneficiaries of the pension plan is clear. Such a position of trust,
if not explicitly extended by statute, is inherent in the office itself.
To the participants and beneficiaries, those with control of the pension
system have control over the most vital aspects of their retirement
years. To a large degree, the economic well-being, and frequently the
physical and emotional well-being of participants in governmental
pension plans are placed in the control of those who administer such
systems. It is apparent that those who control the pension plan
assets, administer the plan, and influence its benefit structure and
funding practices are fiduciaries as that term is used by Chief Judge
Cardozo. This Chapter will explore the degree to which plan fiduciaries
satisfy the standard of behavior spelled out in Meinhard v. Salmon,
and required by society's sense of decency and propriety.
State Representative Dan Angel of Michigan in a recent speech
outlined the scope and importance of the general fiduciary respon-
sibilities that plan officials owe to the plan participants and bene-
ficiaries: "Public pension policy is much, much more than a technical
argument between actuaries. The stakes are perhaps as high as our
lives, our fortunes and our sacred honor." 2
DISCLOSURE
It is easily seen how inadequate or inaccurate communication of
basic plan provisions from plan officials to plan participants and
beneficiaries can produce injustices of an extreme nature. A plan
participant, in making career and personal decisions that will vitally
affect his or her interest in the retirement plan, cannot make those
1 Meinhard v. Salmon, 249 N.Y. 458, 464, 164 N.E. 543, 546 (1928).
2 "The Public Pension Morass", delivered before the National Seminar on Public Pension Issues, Wash-
ington, D.C September 15, 1977. ; , -
(183)
184
decisions intelligently unless given an opportunity to understand the
basic provisions of the pension plan. Consider the situation of a plan
participant who leaves the plan only a few weeks or months prior to-
becoming vested in his plan interest, and who was never adequately
informed of the vesting provisions of the plan by the plan adminis-
trator. Yet, as shown in Table C4, only 46.6 percent of governmental
plans in fact automatically provide this vital information to plan
participants. Similarly, disclosure to the employee of the amount of
his own contributions to the plan is essential to intelligent financial
planning by the plan participant, and presumably ought to be dis-
closed accurately and frequently to plan participants. However, only
49.1 percent of all governmental plans furnish such information to par-
ticipants automatically, while 8.2 percent simply do not furnish such
information, even upon request (Table C4). Disclosure to participants
of the level of accrued benefits likewise is elemental to the maintenance
of a fair and honest relationship between the plan and its participants
and beneficiaries. The surve}T material shows that only 24.8 percent of
governmental plans furnish such information automatically, and 19
percent do not furnish it even upon request (Table C4).
It should be noted that in many instances plan fiduciaries do satisfy
this fiduciary-type standard by regularly and fully disclosing this
crucial information to plan participants. Approximately 92.7 percent
of public employee retirement systems covering teachers automatically
furnish plan descriptions to plan participants. Among plans admin-
istered by the states, 86.5 percent automatically furnish participants
with statements of their contributions. Among teacher plans this
disclosure is made automatically by 97.5 percent of plans. With regard
to statements of accrued benefits, 59.6 percent of state administered
plans, and 85.9 percent of teacher plans, automatically disclose
information regarding accrued benefits (Table C4).
The failure by many governmental plans to fully and regularly dis-
close vital information to plan participants represents a failure by
those pi ans and their officials to fully discharge a portion of their
general fiduciary obligations to plan participants, a failure which un-
doubtedly has produced lasting but easily avoidable harm to plan
participants and beneficiaries.
AWARENESS OF LEGAL PROVISIONS
This same absence of fair and loyal administration of the plan is
sometimes evident in the diligence plan officials demonstrate in learn-
ing of and complying with legal developments that have a significant
impact on the plan participants. The Internal Revenue Code and its
qualification requirements, for instance, can very substantially affect
the design, funding, and administration of public employee retirement
systems, as well as the tax liability of governmental plan participants.3"
Yet 57.5 percent of the governmental plan administrators have indi-
cated that they are not familiar with the qualification process (Table
G5), a lack of awareness which could produce dire consequences for the
plan and its participants. In testimony before the Labor Standards
Subcommittee, Honorable William Wilcox, Secretary of the Depart-
"Supr*, p. 30j
185
ment of Community Affairs of the State of Pennsylvania, refers to-
many communities in Pennsylvania that fail to submit actuarial as-
sessments required by state law, thereby forfeiting certain pension
fund income that would be generated if the local plan officials dili-
gently complied with state legal requirements.4 Part II of this Report
outlines the body of federal law which presently affects the PERS.5
It is highly doubtful that many state and local governmental plan
administrators have a sufficient understanding of that body of law
to enable them to minimize the liabilities their plans might face because
of violations of these regulations and statutes. In each of these in-
stances, the failure of plan officials to act diligently and thoughtfully
in their administration of the plan and discharge of general fiduciary
duties can be detrimental to both the governmental plan and its
participants.
ENFORCEMENT OF PLAN PROVISIONS
The failure of plan officials in some instances to vigorously enforce
the substantive provisions of the plan may also be characterized as a
failure to properly discharge the general fiduciary duties of that plan
office. A report issued b}^ the United States Department of Com-
merce 6 indicates that in June, 1976, among participants of the
District of Columbia Police and Fire Plan receiving benefits under the
plan, only 19 percent were receiving benefits because of age or length of
service, whereas 81 percent were receiving benefits on account of
disability. With regard to the Denver police plan, the report indicates
approximately 40 percent of those receiving benefits under the plan
had satisfied the age and service requirements while nearly 59 percent
of those receiving benefits were doing so under the disability provisions
of the plan. The Denver fire plan, in June of 1972 (the last year for
which records are available), paid benefits under the age and service
part of its plan for only 35 percent of those receiving benefits, and paid
the remaining 64 percent of benefit recipients on account of their
disability. These figures stand in sharp contrast to the vast majority
of governmental plans, in which far more participants qualify for
benefits under the age and service provisions of the plan than under the
disability provisions. To the extent that the high disability retirement
rates result from lax enforcement of disability requirements, the
officials responsible may be in violation of their general fiduciary
responsibilities. Clearly the remaining plan participants and their
beneficiaries, not to mention the taxpayers, suffer as a result of this
type of fiduciary breach. In 1972, for example, the Hudson County,
N.J., Employees Pension Fund was forced into receivership largely
as a result of abuses in the plan's eligibility and disability provisions.
ACCOUNTING^ AUDITING, AND ACTUARIAL STANDARDS
The establishment and maintenance of professional accounting,
auditing, and actuarial practices is part of the general fiduciary
responsibility which plan officials owe to the plan participants. Obvi-
4 Hearings on H.R. 9155, and H.R. 808, before the Subcommittee on Labor Standards, Committee on
Education and Labor, U.S. House of Representatives, 94th Congress, 1st Session, p. 111.
s Supra, p. 7.
• Finances of Employee- Retirement Systems of State and Local Governments in 1975-76, Bureau of the
Census, May, 1977.
186
ously an accurate accounting of the plan's assets and liabilities,
estimation of funding status and expectancies, and auditing of plan
procedures are essential to the honest and responsible operation of the
pension system. In many instances, plan officials admirably dis-
charge these obligations. The survey material and other reported
material suggest, however, that serious problems exist for many
governmental plans in each of these areas.
As indicated in Chapter C, supra, governmental plans frequently
are not subject to the audit and other review procedures to which
private sector plans are subject. About one- third of the state ,and
local plans are not audited on an annual basis. Almost one-half of
governmental plans are not audited by outside auditors. Approxi-
mately 4.6 percent of governmental plans are never audited at all.
With regard to valuation of plan assets, between 60 percent and
70 percent of governmental plans do not disclose the market value of
plan assets, even though market value is clearly important to the
measurement of the solvency, investment performance, and general
financial condition of a plan.
In the context of actuarial valuations, the survey shows that about
45 percent of public plans receive actuarial reviews annually whereas
nearly one-third of all plans have had no actuarial review within
the last five years. Almost 25 percent of governmental plans have not
had such a review for at least ten years.
Furthermore, the absence of uniform accounting, auditing, and
actuarial standards for governmental plans makes the measure-
ments and practices that are performed of questionable validity.
The Municipal Finance Officers Association, in issuing its guide-
lines regarding disclosure of unfunded pension plan liabilities, im-
plicitly recognizes the need for improved standards in this area.
Similarly, statements by the bond rating services suggesting a high
level of skepticism with regard to the valuations presently made
reflect both the need for heightened accounting, auditing, and actuarial
standards for public plans generally, as well as greater uniformity
regarding terminology and methodology in each of these areas.7
CORRUPTION AND DISHONESTY
A closely related issue involves the need for accounting and audit-
ing standards, as well as personal conduct standards for plan officials,
in the context of corruption and dishonesty among plan officials
and others dealing with the plan. Dr. David Bronner, Secretary-
Treasurer of the Alabama Retirement Systems, recently noted that
his funds had \ 'absolutely no policy guidelines for the person in my
position. There are no policies on such things as self -dealing, dealing
in hot issues . . . There is no policy requiring disclosure of any
transactions I make for my personal account, no disclosure of who
loans are made to and any relationship the person in my position may
have with those parties".8
Obviously the absence of such standards does not necessarily mean
that plan officials will proceed to act dishonestly. Indeed, Bronner
made his comments in reporting bribe attempts made by brokers who
7 See, e.g., Pensions and Investments, Aupust 15, 1977, p. 50.
8 Pensions and Investments, October 25, 1976, p. 5.
187
were attempting to persuade him to invest the funds' assets in a
particular manner. But the absence of such standards no doubt
increases the likelihood of such abuses. Bronner suggests that the
absence of such controls in Alabama served as "an open invitation to
the wrong kinds of people".9 Pension consultant Robert Tilove
recently wrote that "Preventing corruption requires a system of
accountability by those who make the decisions, full recordkeeping,
reporting and disclosure, and a system of independent audits and
evaluative reviews." 10
The institution and maintenance of professional auditing, account-
ing, and actuarial practices, and the enforcement of a code of behavior
for plan officials is central to both proper operation of a public em-
ployee retirement s}^stem and the satisfactory discharge by plan
officials of their general fiduciaiy responsibilities.
RECORDKEEPING AND CLAIMS PROCEDURES
Other aspects of plan administration which involve general fiduciary
responsibilities are the recordkeeping practices and claims procedures
of state and local governmental plans. Chapter C discusses the
laxities and deficiencies occasionally found in a governmental plan's
collection and retention of data relating to participants' service
records, entitlements, amounts of contributions, and so on. Obviously,
deficient plan practices in these areas can cause serious harm to par-
ticipants. Those entitled to benefits may never get them. Persons not
entitled under the plan may unjustly receive benefits. Terminating
employees who are denied accurate information on the value of ac-
cumulated contributions and vested benefits may be unable to intel-
ligently and economically elect whether to withdraw their contribu-
tions, remain in the plan, and so on. Obviously inadequate record-
keeping by plan administrators represents a breach of the general
fiduciary responsibility that plan officials owe to participants and
beneficiaries as an element of their positions as plan officials.
Less than open and fair claims review procedures represent a similar
disservice to plan participants and beneficiaries. An element of
responsible plan administration necessarily includes the review of
participants' claims by plan officials who fully understand the relevant
plan provisions and are sufficiently removed from daily involvement
with the applicant to permit impartial review of the claim for benefits.
Written notice of the reason for denial of a claim and an opportunity
for the participant to refute the basis of that denial are equally im-
portant components of a claims review procedure that purports to be
fair and responsive to the relationship of trust and confidence which
exists between the plan participant and plan officials.
DILIGENCE
A general obligation to act diligently and conscientiously to further
the interests of the pension plan and its participants and beneficiaries
is an additional component of the fiduciary responsibilities incumbent
on plan officials. The precise nature of this duty, as might be expected,
»7d.
i° Public Employee Pension Funds, by Robert Tilove (Columbia University Press, N.Y. 1976), p. 217;
74-365—78 13
188
varies considerably, dependent on the nature of the event affecting the
plan and the position of the plan official who is involved. For instance, a
failure of plan officials to affirmatively respond to a proposed alteration
in the plan benefit structure that would undermine the fiscal solvency
of the plan may be characterized as a breach of their general fiduciary
obligations to the plan. Similarly, if a plan official becomes aware of a
plan practice or proposed plan provision that, for example, directly
contravenes the applicable Internal Revenue Code limitations on
benefits (section 415) by paying a participant in a defined benefit
plan an annual benefit that exceeds 100 percent of the average compen-
sation for the participant's high three years, then it is apparent that
the plan official should take appropriate action to so inform the legis-
lature or other persons who may be responsible and capable of taking
corrective measures. The same would be true of other applicable state
and federal law requirements. To stand by idly while actions take
place which would seriously undermine the stability and soundness of
the pension plan can hardly be said to be appropriate action under the
general fiduciary standards applicable to plan officials. While this
aspect of fiduciary behavior is perhaps too subtle to be drafted into a
readily comprehensible code of conduct, it has at its core a high degree
of conscientiousness and thoughtfulness by plan officials with regard
to the general operation of the plan and, of course, the welfare of
the plan participants and beneficiaries.
PLAN ASSETS AND FIDUCIARY RESPONSIBILITY
Fiduciary responsibility provisions in the specific context of the
management and investment of public employee retirement plan
assets (as opposed to plan administration generally) are also of tre-
mendous consequence to the participants and beneficiaries of govern-
mental plans. Indeed, it is difficult to imagine an element of pension
plan operations for which Judge Cardozo's admonition in Meinhard v.
Salmon 11 is more appropriate. There is virtual unanimity within the
pension community that those who have control of pension plan assets
and direct the investment of such assets should be held to high stand-
ards of behavior and should face liability upon failing to satisfy that
standard.
Yet throughout the universe of state and local government retire-
ment systems there is a virtual absence of clear guidelines in this vital
area.
Initially, the term "fiduciary" is itself seldom clearly defined in the
various state and local plans. Hence it is unclear which plan officials
(e.g. trustees, investment advisors, attorneys, accountants, actuaries,
administrators, custodians, etc.) are subject to whatever standard of
conduct is required under state or local law for trustees and fiduci-
aries generally, and pension plan trustees and fiduciaries specifically.
The substance of the standard of conduct to which plan trustees
and fiduciaries with plan asset management and investment respon-
sibilities are subject is also seldom set forth with any clarity. Thus
even when it is perceived that a trustee's conduct or an investment
manager's performance has been unsatisfactory^, or even irresponsible
11 Supra, note 1.
189
and highly imprudent, the absence of a codified, substantive standard
of conduct to which the fiduciary can be held frequently precludes
recovery by the plan or its aggrieved participants. A review of well-
known public plan "abuses" demonstrates that the erring plan fidu-
ciary is seldom held liable to the plan for the damages the fiduciary's
irresponsible actions have caused to the plan, its participants, and the
sponsoring governmental entity.
Furthermore, the relationship, in terms of responsibilities, between
various plan trustees and fiduciaries is seldom set forth. Plan partic-
ipants frequently do not enjoy the protection that results from an
asset management and investment methodology whereby certain
plan trustees and fiduciaries, in appropriate circumstances, are held
responsible for the proper discharge of duties by a co-trustee or co-
fiduciary. The absence of satisfactory standards to govern these
relationships may result in unnecessary and costly mishandling of
plan assets and the inefficient investment of plan assets, all of which,
in one form or another, ultimately injures plan participants, the
sponsoring governmental entity, and the citizens and taxpayers of
that entity.
The public plan universe, in a related area, frequently fails to place
control of investments in a person or group possessing the sophisti-
cation to adequately direct such investments or to adequately direct
the selection of a qualified, professional, investment manager who in
turn would direct the specific investments. Louis Kohlmeier in his
study 12 (see Appendix XIV) discusses the experiences of the public
pension system of Albany, Georgia. That city's pension fund had
earned an annual return on investments of 1.1 percent for an eleven
year period during Avhich the chairman of the city pension board was a
director of the bank which served as the fund's investment manager.
The Survey material (Table C2, supra), indicates that only 2.1
percent of state and local government pension plans maintain a
separate investment board, presumably containing expertise with
regard to the investment of plan assets. It must be noted that the mere
absence of a specialized investment board does not necessarily produce
poor or unprofessional investment policy. In conjunction with the
absence of general fiduciary standards in the context of plan invest-
ments and asset management, however, the absence of specialized
investment boards no doubt generates certain deficiencies in asset
management and investment. A review of the Census Bureau's Keport
on state and local government retirement systems, for example, reveals
that many small plans, not having the benefit of investment expertise,
retain an extremely high percentage of plan assets in cash and similar
deposits.
One pension commentator has suggested that limitations often
found on a public plan's ability to pay top dollar for investment
advice, and the "widespread belief that the system's board of direc-
tors must be personally responsible for day-to-day transactions,"
have significantly hampered the effective management of PERS plan
assets.13 Another pension commentator recently addressed the issue
12 Conflict of Interest: State and Local Pension Fund Asset Management, (20th Century Fund, N.Y.), 1976.
13 Public Funds; The Herculean Task is Under Way," by Barbara A. Patocka, Pensions, May/June,
1973, p. 36.
190
of control and investment of plan assets by non-expert trustees and
other plan officials and stated :
In many public systems, the power to decide on investment rests in the hands
of trustees who are not equipped to make investment decisions. The board fre-
quently consists largely of public officials and employee representatives who do
not have the relevant background — yet they are generally legally required to
make decisions ...
If the final responsibility for deciding on each transaction rests with a board
of trustees it is unlikely in most cases that an optimum investment policy will bo
followed. Trustees are burdened with responsibilities which, in most cases, they
are not trained to fulfill. . . ,14
The frequent placement in the PERS of plan asset management and
investment authority7- in non-expert plan officials often produces
investment policies and practices that are significantly less valuable
than that expected from professional investment advisors and man-
agers, and generally found in private sector plans. To the extent
that the plan thereby foregoes investment income which it might
otherwise earn, it is the plan participants and plan sponsor that suffer.
This Chapter (supra) discusses at length the auditing, accounting,
and reporting practices of state and local government pension plans
and how such practices, if deficient, may represent breaches of the
general fiduciary obligations which plan officials owe to plan partici-
pants and beneficiaries.15
It is readily apparent that unsatisfacton^ practices in these vital
areas can contribute to inappropriate management of assets and
improper investment decisions. Recall that between 60 percent and
70 percent of governmental plans do not disclose the market value
of plan assets.16 It does not seem possible that proper investment
decisions can be made if the current market value of various plan
assets is not regularly tabulated. Whether a plan asset in the form of a
readily marketable security should be held or sold by the plan must
be based, at least in part, on the present market value of the security.
An article in Pensions11 notes how certain public pension systems
shifted their portfolios from issues favoring the payment of dividends
to issues favoring capital growth, following an alteration in the ac-
counting technique of the plan to permit the actuarial recognition of
certain unrealized capital gains. A recent investment survey conducted
jointly by the Pension Research Council of the University of Pennsyl-
vania and the Pension Task Force suggests that accounting methods
affect investment decisions in one-fourth of large public employee
retirement systems. The improper maintenance of accounting, audit-
ing, actuarial, and reporting standards can produce a fiduciary
breach by a plan official in the specific context of plan asset manage-
ment and investment as readily as such deficient practices can gen-
erate shortcomings with regard to a plan official's general fiduciary
obligations.
LOCAL INVESTMENTS
The recurring tendency on the part of governmental plan fiduciaries
to manage and invest plan assets in a manner consciously designed
to benefit various local interests represents a relatively well recog-
H Supra, note 10 at p. 211, 213.
is Cf. Chapter C.
M Snpra, p. 186.
17 .Supra, note 13, at p. 38.
191
nized problem with regard to the investment of public plan assets.
This investment and management proclivity becomes undesirable
when plan trustees and fiduciaries favor locally-oriented service pro-
viders and investments despite the fact that such investments may
not be in the best interests of the plan and its participants. Louis
Kohlmeier, in his study (see Appendix XIV) states:
One of the most persistent conflict-of-interest situations in the management of
public pension funds results from the policy, followed by many funds, of hiring
local bankers, brokers, and investment advisors and the practice of investing
in local securities, even though better — or lower cost — services and higher yielding
investments may well be available outside local boundaries.18
Similar findings, particularly with regard to the use of home state
custodians, are contained in an article in Pensions.19
Often, it should be noted, use of local service providers and invest-
ment in local real estate and securities issuers is mandated by statute
or custom. Pennsylvania, for instance, for many years restricted state
pension fund investments in mortgages on real property to property
within Pennsylvania.20 Illinois law has required that the custodian of
certain state pension fund assets must be an Illinois bank.21 The direc-
tor of the New Jersey State Investment Council, which directs the
investment of certain state retirement systems, has acknowledged
that strong pressure is exerted on him to trade securities through
New Jersey brokerage firms, or at least through brokerage firms that
maintain New Jersey offices.22 The general problem is clearly wide-
spread. The Pension Research Council-Pension Task Force investment
survey found that nearly one-fifth of large public systems were limited
by statute or policy to selecting only those entities with in-state or
local offices as outside investment advisors. Almost two-thirds of all
governmental plans were found to be required by statute or policy
to use local or in-state brokerage firms to execute trades. More than
one-half of large public systems were found to be restricted by statute
or policy to the selection of in-state or local asset custodians.
Even though these locally oriented practices are frequently insti-
tuted or maintained with the honorable intention of creating jobs in
the local area, generating local tax revenues, increasing the capital
available for local business expansion, and so on, it is the plan and its
participants who experience the injury when such practices occur
despite the availability of a better service arrangement or investment
elsewhere. For instance, the most expert investment advice may not
be available locally. Similarly, the most economical brokerage or
custodial services for the plan may be available from a firm that does
not maintain a local office. Obviously, the best investment available,
whether in real estate or otherwise, is not necessarily located within
the geographical confines of the political unit in which the pension
plan is located. The same, of course, is true of custodians, advisors,
and so on.
Plan participants and beneficiaries should, at a minimum, be entitled
to have the assets of their retirement system invested in a manner
which will generate the greatest overall benefit for the pension plan.
1S Supra, note 12 at p. 23.
19 Supra, note 13 at p. 40.
18 Supra, note 12 at p. 23.
41 Supra, note 19 at p. 40.
» Institutional Investor, July 7, 1975, p. 65.
192
When assets are managed or invested for any purpose, no matter how
meritorious in terms of general social policy, other than to benefit the
participants of the pension plan, the legitimate interests of the plan
participants are jeopardized.
SUBSTANTIVE STANDARDS
A closely related issue involves the specific substantive standards
which ought to govern public plan fiduciaries who manage and invest
plan assets. Questions at the very core of the duties of governmental
plan trustees and fiduciaries with control over plan assets readily
appear: To what purposes should pension plan assets be put? To whom
do plan fiduciaries and trustees owe their loyalities? What guidelines
should govern the investment and management of governmental plan
assets?
Conventional trust law, as amplified by this section's opening
quotation from Meinhard v. Salmon,23 as well as the virtually unani-
mous view that pension plan benefits have been earned by plan
participants and that the associated plan assets therefore "belong"
exclusively to them rather than to the sponsoring governmental
entity, require that the above questions be resolved in the manner
most favorable to plan participants and beneficiaries. That is, pension
assets should be used for the sole purpose of providing benefits and
defraying administrative costs. Plan fiduciaries and trustees should
owe then primary loyalties to the plan participants and beneficiaries.
Finally, the management and investment of plan assets should be
accomplished by plan trustees and fiduciaries (1) using the care, skill,
prudence, and diligence under the circumstances then prevailing that
a prudent man acting in a like capacity and familiar with such matters
would use in the conduct of an enterprise of a like character and with
like aims, and (2) diversifying the investments of the plan to minimize
the risk of large losses, unless under the circumstances it is clearly
prudent not to do so.
A review of the record, however, amply demonstrates that public
plan trustees and fiduciaries frequently do not satisfy these standards
in this most vital area, to the substantial detriment of plan beneficiaries
and participants.
Consider the locally-oriented investment practices described above.
A decision to retain a particular service provider because the provider
is based locally strongly suggests that the fiduciary may not be using
plan assets exclusively to provide benefits and defray reasonable
administrative costs. A decision to limit certain kinds of plan invest-
ments to securities or property located where the plan is located
ignores the possibility that a more prudent and more productive
investment might be found elsewhere. Similarly, a preference for
investments with a local flavor may raise issues of conflicting loyalties
on the part of the plan fiduciary considering a potential investment.
An investment decision that might indicate a high sense of loyalty to
a state or city (e.g., buying industrial development bonds of a declining
municipality) may well conflict with the fiduciary's obligation of
loyalty to the plan participants. It is questionable, for instance,
23 Supra, note 1.
193
whether the exclusive use of North Dakota's two licensed brokers for
all trades involving the North Dakota state retirement system is
necessarily most beneficial to plan participants and beneficiaries.24 It
is certainly conceivable that a more competitive method of selecting
brokers, including the consideration of out-of-state brokers, might
result in better brokerage rates, and so on.
The frequent purchase of tax-exempt securities by state and local
government pension plans represents a vivid example of failure by
plan trustees and fiduciaries to satisfy both general fiduciary standards
and the specific substantive standards that apply to the management
and investment of plan assets. It is clear that many plans invest large
percentages of plan assets in such securities. A recent report by the
Census Bureau 25 reveals, for instance, that the general retirement
system for Revere, Massachusetts had invested 59 percent of its assets
in state and local government securities. For the general fund of
Jersey City, New Jersey, the figure is 35 percent, and for the New
York City Teachers' Retirement System, the figure is 30 percent.
There is near universal agreement among knowledgeable observers
that it is inherently imprudent for a tax-exempt governmental pension
plan to invest in tax-exempt state and local government securities.
One commentator states : "[F] or a tax-exempt pension fund, investing;
in tax-exempt state or local obligations is, with rare exception,
senseless." 26
A similar attitude is expressed by an official of the Ohio State
Teachers' Retirement System, who states: "I cannot see why there
should be any great interest on the part of tax-exempt organizations
in the purchase of tax-exempt securities. The lower yields available
on state and municipal debts can only increase the liability of the
employer." 27
When the governmental pension plan fiduciary invests plan assets
in tax-exempt securities issued by the plan sponsor, the fiduciary may
well be acting not only imprudently, but also in violation of the duty
to use plan assets exclusively to benefit the participants and to act
with primary loyalty to participants. It is of course possible that the
fiduciary who directs the investment in good faith perceives that the
best investment available is the purchase of securities issued by the
plan sponsor. But frequently, it is clear, the purchase is made pri-
marily to benefit the issuing municipality or state, rather than plan
participants and their beneficiaries. One observer has noted: "In
practice . . . the fund's investments in the obligations of their own
states and muuicipalities do not seem to have been made for any
high public or social purpose. Although their motivations are buried
in unrecorded history, it is likely that the commitments were made
by state and municipal treasurers as a matter of convenience — and
occasional necessity — to support the market for public obligations or
even to fund some pet political project." 28 It is well recognized that
the purchase of $2.5 billion of New York City bonds by five New York
« Supra, note 10 at p. 24.
» Supra, note 6.
28 Supra, note 10 at p. 205.
J7 Letter of James L. Sublett, quoted at p. 46, Conflicts of Interest: State and Local Pension Funds Asset
Management, supra, note 12.
» Supra note 12 at p. 45-46.
194
City Pension Funds was done primarily as an attempt by the plan
trustees to stave off bankruptcy by the city.
Inasmuch as the agreement to purchase the city securities was
itself contingent on (1) exemption of the purchases from the Internal
Revenue Code prohibited transaction and exclusive benefit rules, and
(2) passage by the New York legislature of a bill indemnifying the
plan trustees against liability for making such purchases, it was
implicitly recognized by all the parties to the agreement that govern-
mental plan assets were to be used for some purpose other than
generating income to the fund or defraying reasonable administrative
expenses. The fiscal emergency faced by New York City of course
bears heavily on any consideration of these events. Similar investments
have been made by other municipalities and states. To the extent that
plan officials, in approving investments in securities issued by plan
sponsors, base that investment decision on something other than a
concern if or the welfare of the beneficiaries of their trust obligations,
the duty of exhibiting primary loyalty to plan participants appears to
be unfulfilled. The issue is made more complex by the fact that govern-
ment officials frequently serve as plan fiduciaries, often in an ex officio
capacity.
MANAGEMENT AND INVESTMENT LIMITATIONS
Although a great manj^ governmental plans exhibit a high level of
professionalism and sophistication in the management and invest-
ment of the plan assets, it is clear that many governmental plans do
not. Professional and efficient conduct by plan fiduciaries in the
management of the investment portfolio and the selection of invest-
ments and investment advisors are essential elements of prudence
in the context of the management and investment of plan assets. The
failure to conduct such matters professionally and efficiently repre-
sents a breach of fiduciary obligation with regard to the assets involved.
This problem recurs in a variety of forms. In many instances,
trustees and other plan fiduciaries are sharply limited by law with
regard to the kinds of investments that can be made. "Legal fists",
containing an exhaustive list of permitted investments, are still found
in some states, although not as frequently as in the past.29 Some states
by law still restrict the degree to which public plan assets can be in-
vested in various categories of investments (e.g. common stocks).30
Frequently, this unsophisticated investment attitude stems directly
from the plan trustees and fiduciaries themselves. Many plans, for
instance, do not sell securities which are currently listed below book
value, for fear of showing a capital loss, despite the fact that taking
the loss and reinvesting the proceeds might well generate more income
to the plan in the end.31 Inactive management of the portfolio of
government plans appears to be common in the public sector, as
revealed by turnover rates far below that found among private sector
funds and other money managers.32
Similarly, restrictions are sometimes found on a plan's ability to use
plan assets to secure first rate investment and management advice.
28 Supra, note 10, at p. 201.
»° Supra, note 10, at p. 202; see aho Chapter F, infra:
11 Supra, note 10, p. 206.
« Supra, note 10, at pp. 210-11.
195
Whether resulting from statutory limitations imposed by the legisla-
ture, or a vain and parochial attitude on the part of the plan officials
responsible for making investments, the failure to secure qualified
investment advice, including review of investments on an ongoing
basis, may represent a failure by the fiduciar}?- to act prudently and in
the best interests of the plan participants and beneficiaries.33
A number of additional observations are in order. Most individuals
who serve as trustees and fiduciaries of their state and local govern-
mental retirement systems demonstrate a sense of diligence, intelli-
gence, good-faith, and honesty in the performance of their duties.
Hence it is not surprising, and largely because of the efforts of these
dedicated officials, that informed observers in discussing governmental
plans in recent years could comment that "overall, with all the con-
siderable problems that remain, the public employee retirement system
has made enormous and genuine progress in the past few years",34
and "In the past two decades, public systems have radically improved
their investment policies and procedures." 35
Yet the record unquestionably demonstrates that many govern-
mental plans do not conduct fiduciary matters, both generally and
with regard to the management and investment of plan assets, in a
manner that affords plan participants and beneficiaries the protection
to which they should be entitled. The grave importance of proper
administration of a retirement system and pension funds that are
designed to provide retirement income to employees and their bene-
ficiaries requires that safeguards and procedures be maintained in
order to insure, as nearly as possible, that the "punctilio of an honor
the most sensitive" 36 is indeed the standard of behavior for those
charged with such responsibility. Taken as a whole, the PERS
universe at present all too often lacks such safeguards and procedures,
and fiduciary abuse, whether in the form of diminished investment
income, mishandled plan assets, inept enforcement of benefit eligibility
requirements, insufficient disclosure of plan provisions to partici-
pants, and even plan insolvency and bankruptcy, have too frequently
been the result.
SUMMARY AND CONCLUSIONS
1. Management, accounting, auditing, and disclosure practices
Public employee retirement systems frequently lack adequate ad-
ministrative controls, thereby hindering proper plan operations.
About one-third of the total number of governmental pension plans
lack annual audits. Nearly one-half of such plans have never had
external independent reviews. Incredibly, over 8 percent of the pen-
sion plans covering local government employees have never been
audited. Approximately one-third of the governmental plans have
been neglected actuarially, most never having conducted an actuarial
valuation. The absence of uniform accounting, auditing, and actuarial
standards for governmental plans makes the measurements and prac-
tices that are performed of questionable validity.
M Supra, note 13 at p. 36.
34 Supra, note 13 at p. 4S.
35 Supra, note 10 at p. 220.
36 Supra, note 1.
196
The lack of accountability of public pension plan fiduciaries has led
to violations of the Internal Revenue Code and possibly other federal
laws, failure to disclose information vital to the interests of plan
participants, and to favoritism and abuse in benefit determinations.
Nearly 60 percent of the public pension plan administrators stated
that they are unfamiliar with the application of the Internal Revenue
Code qualification process to their plans, a lack of awareness which
needlessly places plan assets and participant benefits in jeopardy of
federal taxation. In many cases plan participants are not informed
of basic plan provisions or the amount of their vested benefits, result-
ing in the unwarranted forfeiture of millions of dollars of earned pen-
sion benefits. In other cases, the lax enforcement of disability require-
ments has caused unwarranted drains on pension plan assets. Such
abuse even forced one plan, the Hudson County, New Jersey Employ-
ees Pension Fund, into receivership.
The inadequate accounting, auditing, actuarial, recordkeeping, dis-
closure, and other administrative practices found in many public
pension plans represent a failure by those plans and their officials to
fully discharge their general fiduciary obligations to plan participants.
Plan fiduciaries should be required to act prudently and for the
exclusive purpose of providing benefits to plan participants and
beneficiaries.
2. Investment restrictions and limitations
Various statutory and self-imposed policy restrictions on public
pension plan investments and investment practices have impaired
plan investment returns and created needless conflicts of interest.
Restrictions and pressures to use local investment services, regard-
less of whether such services are of the best quality at the most favor-
able price, are widespread. The Pension Task Force — Pension Re-
search Council investment survey shows that outside investment
advisors for nearly one-fifth of the large state and local retirement
S3^stems are limited by statute or policy to those service providers
with in-state or local offices. Similarly, nearly two-thirds of such plans
are restricted to using local or in-state brokerage firms to execute
trades. More than one-half of such systems are also restricted to using
in-state or local custodians. This kind of parochialism often carries
over into mortgage and real estate investment policies limiting such
investments to in-state or local properties.
The investment performance of many state and local pension funds
continues to be hampered because of statutory and policy restrictions
on investment expenses and portfolio composition. First rate invest-
ment management and advice may be foreclosed to the pension plans
having such restrictions. "Legal lists", containing an exhaustive list
of permitted investments, are still found in some states. About 10 per-
cent of the large state and local plans still preclude common stock
investments. In 60 percent of such plans common stock investment is
limited to less than 35 percent of total pension plan assets.
The unsophisticated investment attitudes of the plan trustees in
some plans permit plan accounting practices to preclude certain
investment transactions, such as "bond swaps", which would improve
long-term plan investment returns. One-fourth of the large public
197
pension plans responding to the Pension Task Force investment
survey indicated that accounting methods do in fact affect invest-
ment decisions.
Clearly the various investment restrictions confronting public
employee retirement systems hinder the efficiency of the total port-
folio management of such plans. In fact, nearly one-fourth of the
large state and local public pension plans responding to the Pension
Task Force-Pension Research Council investment survey indicated
that such restrictions impaired pension fund investment performance
over the past five years.
3. Plan assets and fiduciary responsibility
Throughout the universe of state and local public employee retire-
ment systems, there is a virtual absence of clear fiduciary responsi-
bility guidelines. The term "fiduciary", where it does appear (see
Appendix V for a state by state analysis), is seldom clearly defined.
Also, the standard of conduct to which trustees and fiduciaries may
be subject is seldom set forth with clarity.
Because of the absence of adequate fiduciary standards and of
investment policy guidelines requiring recordkeeping, reporting, dis-
closure, and independent audits and reviews, conflicts of interest in
the public pension arena have often ripened into clear examples of
fiduciary abuse. After being offered a bribe, the Secretary-Treasurer
of one large state retirement system remarked that his system has
absolutely no policy guidelines regarding self-dealing or requiring
disclosure of party-in-interest loans or similar transactions. Partly
because the lack of preventive safeguards present open invitations for
abuse, public officials have in the past been charged and convicted of
bribery in relation to public pension plan investments.
In other instances, public pension funds have lost income because
of imprudent asset holdings in low-interest and non-interest bearing
bank accounts. The assets of some plans have been diminished and
depleted because of unqualified investment advice. The absence of
codified substantive standards of conduct making fiduciaries respons-
ible for their imprudent actions has frequently prevented aggrieved
pension plans and their participants from recovering the losses they
have incurred.
The absence in many public pension plans of responsible or profes-
sional investment management is clearly illustrated by the fact that
between 60 percent and 70 percent of governmental pension plans do
not compute or disclose the market value of plan assets, even though
market value is clearly important to the measurement of the solvency,
investment performance, and general financial condition of a pension
plan.
After a period of diminishing public pension plan investment in
state and local government securities, such investments are on the
increase in some plans. In most cases, such investments are inappro-
priate in light of the low-yielding, non-taxable nature of such securities
and the tax-exempt nature of governmental plans. Because the invest-
ment of public pension funds in state and local government securities
usually lowers investment returns unnecessarily, and is fraught with
conflict of interest and great potential for the impairment of pension
plan stability, the investment of plan assets in state and local govern-
198
ment securities should be limited and subject to a prudence
requirement.
The existing standard of care which governmental plan fiduciaries
are required to satisfy is inadequate with regard to the investment and
management of pension plan assets. Fiduciaries should be required to
act prudently and for the exclusive purpose of providing benefits to
plan participants and beneficiaries, in accordance with the principle
that pension benefits have been earned by plan participants and that
the associated plan assets therefore "belong" exclusively to them rather
than to the sponsoring government.
APPENDIX I
TABULAR RESULTS OF THE PENSION TASK FORCE
SURVEY OF PUBLIC EMPLOYEE RETIREMENT SYS-
TEMS
EXPLANATION OF THE TABULAR DATA FROM THE PENSION TASK FORCE
SURVEY OF PUBLIC EMPLOYEE RETIREMENT SYSTEMS
The data from the Pension Task Force Survey of Public Emplo3'ee
Retirement Systems is presented in the 59 tables contained in this
Appendix. The survey data is presented in an extremely detailed for-
mat in order that the information be of maximum usefulness to plan
administrators, public officials, public employees, and others having
an interest in public employee retirement s}Tstems.
Before proceeding to an explanation of the tables, the reader's
attention is directed to Appendix III which describes the survey
methodology. Generally, the survey data is presented separately for
federal systems (see Appendix IV for a listing of the 68 federal plans)
and for the systems covering state and local government employees.
The data for state and local systems is presented 1) by size of system,
2) by level of administration (whether b}~ the state or by a local unit
of government regardless of whether the employees covered are state
employees or local government employees), 3) by system coverage
type (the three categories — state and local government, police and
fire, and teachers including higher education — summarize the more
detailed breakouts by system type under "level of administration"),
and 4) by social securit}^ coverage (a system is considered "covered"
if the majorit}?" of the active employees are also contributing to social
security)- The categories under "size of system" correspond to the
three strata used iu the surve}^ sampling of state and local systems.
The "large" strata covers plans having 1,000 or more active members;
the "medium" strata covers plans having 100 to 999 active members,
and the "small" strata covers plans having less than 100 active
members.
The table percentages are generally based on percent of plans unless
percent of employees is indicated (e.g., Tables 16 and 21). The Tables
52-59 relating to funding are based only on retirement systems having
a defined benefit pension formula (a small percentage of such plans
also have defined contribution features as part of the overall benefit
structure) .
(199)
200
The technical notes in Appendix III describe the reasons why an
exceptionally high degree of reliance can be placed on the accuracy
and completeness of the data from this survey as compared with other
"statistical samples". While the response rate for all systems receiving
the survey questionnaire was 94%, the systems responding covered
over 96% of the public employees having pension coverage at the
State and local government level. The percentage of systems for
which the answer to a particular survey question is "unknown" can
be seen to be quite small for most of the tables. In certain cases where
further investigation revealed no reasons to believe the unknown to
be distributed differently than the known data and where the unknown
was relatively insignificant, the unknown was redistributed in pro-
portion to the known data with the percentage unknown relegated to
a footnote. The percentage unknown for the federal strata is negligible
unless shown.
The reader can gain a greater understanding of the labeled responses
by referring to the appropriate question of the Survey Questionnaire
as given in the "Note" at the end of each table. Data items in all
tables appear as blanks if less than .1%. Due to rounding, the data
items in a given category may not add to 100.0% exactly. The foot-
notes form an integral part of each table and should not be overlooked.
201
APPENDIX I
TABLES
Related question
Table number in survey
No. Title questionnaire
1 Retirement system fiscal years: Last month of 12-month period 4.
2 Date of retirement system establishment or major restructuring 5.
3 Form of retirement system establishment 5.
4 Date of most recent addition of new employee group to retirements system 6.
5 Number of employers contributing to retirement system 7.
6 Accounting treatment of retirement system assets, liabilities, receipts and disbursements... 8-9.
7 Retirement system administration _ 10.
8 Characteristics and composition of system retirement boards 11.
9 Custodian of retirement system assets 12.
10 Extent to which retirement systems affected by collective bargaining 13.
11 Extent to which retirement systems audited 14.
12 Retirement system disclsoure to members 15-18.
13 Application of Internal Revenue Code qualification procedures under sec. 401(a) to retire- 19.
ment systems.
14 Retirement system active employees and percentage of active employees covered by social 20.
security.
15 Retirement system retirees, survivors, and terminated vested employees 22.
16 Retirement system membership requirements— percent of active employees 23-24.
17 Retirement system membership requirements— percent of plans 23-24.
18 Retirement system provisions relating to employee contributions 25-27.
19 Distribution of the level of employee contribution rates 26.
20 Retirement system provisions relating to the withdrawal of mandatory employee contributions. 28-31.
21 Retirement system vesting provisions— percent of employees 32-33.
22 Retirement system vesting provisions— percent of plans 32-33.
23 Currently active employees who meet retirement system vesting requirements 32.
24 Retirement system break-in-service and preparticipation service rules 34-35.
25 Retirement system normal and early retirement provisions 37, items 1, 2, 5.
26 Retirement system provisions for a minimum benefit guarantee and for a maximum benefit 37, items 3, 4.
limit.
27 Retirement system provisions for service-connected total permanent disability 37, item 6.
28 Retirement system provisions for nonservice-connected total permanent disability 37, item 7.
29 Retirement system provisions for service-connected partial disability 37, item 8.
30 Retirement system provisions for nonservice-connected partial disability 37, item 9.
31 Retiiement system provisions for disability payment reductions on account of social security 37, items 10, 11.
or workmens compensation and other disability benefits.
32 Retirement system provisions for preretirement death benefits 37, items 12, 13,
14, 15, 16.
33 Retirement system provisions for postretirement death benefits 37, items 17, 18,
19, 20, 21, 22.
34 Retirement system provisions relating to tax sheltered annuities and member borrowing 37, items 25, 6.
35 Distribution of active employees and retirment systems by plan type . ._ 37-38.
36 Kinds of compensation included in computing retirement benefits under defined benefit 39.
retirement systems.
37 Period of years used in computing retirement benefits under defined benefit retirement 40.
systems.
38 Formulas used for computing retirement benefits under defined benefit retirement systems.. 41.
39 Formula rates used for computing retirement benefits under defined benefit retirement 41.
systems.
40 Methods used by retirement systems for computing post-retirement cost-of-living adjustments. 42.
41 Constitutional and legal provisions prohibiting the impairment of retirement system benefits. 43. 44.
42 Retirement system average income replacement rates by social security coverage status, 45.
integration of plan benefits with social security, wage level, and employee category.
43 Distribution of income replacement rates for State and local retirement systems 45.
44 Retirement system income replacement rates by collective bargaining status as compared 45.
with national average income replacement rates.
45 Retirement system income replacement rates by methods of postretirement benefit adjust- 45.
ment as compared with national average income replacement rates.
46 Retirement system income replacement rates by geographic area as compared with national 45.
average income replacement rates.
47 Retirement system portability provisions 46.
48 Sources of retirement system financing 47-48.
49 Retirement system finances 50.
50 Relationship of retirement system assets at market value to book value 50, items 1, 2.
51 Methods used by retirement systems for computing book value of system assets 51.
52 Methods of funding defined benefit retirement systems 52-55.
53 Frequency of defined benefit retirement system actuarial valuations 56.
54 Retirement system actuarial interest rate, withdrawal, salary scale, inflation, and retirement 58.
age assumptions.
55 Retirement system actuarial assumptions: use of separate disability table 58.
56 Distribution of the ratio of retirement system assets to actuarial present value of benefit 59, items 1, 4.
payments.
57 Cumulative distribution of ratio of system assets to benefit payments for different subsets 50, 59.
of defined benefit retirement systems.
58 Methods of funding used by different subsets of defined benefit retirement systems 52-55, 59.
59 Methods used by retirement systems for computing the actuarial value of system assets 60.
202
203
TABLE 3.— FORM OF RETIREMENT SYSTEM ESTABLISHMENT
System category
Percent of plans
Withdrew
Created from Restruc-
by larger tured old
merger system system
Dis-
banded
old
system-
created
new one
Other Unknown
Total
100
I. Federal Government
STATE AND LOCAL GOVERNMENT
14.5
81.9
State administration
4.8
5.3
2.5
1.2
12.4
10.1
6.2
8.3
69.4
70.8
5.0
4.8
100
100
Local administration
4.4
3.4
14.5
4.5
65.6
7.8
100
B. Medium
2.6
3.7
9.2
7.2
72.5
4.4
100
C. Small....
2.1 ...
9.1
5.6
74.8
8.4
100
Total
2.4
.7
9.3
5.9
74.0
7.5
100
Ncte: Table relates to question 5.
TABLE 4.— DATE OF MOST RECENT ADDITION OF NEW EMPLOYEE GROUP TO RETIREMENT SYSTEM
System category
Percent of plans
1955 and
Never 1971-76 1966-70 1961-65 1956-60 before
Un-
known
Total
I. Federal Government...
STATE AND LOCAL GOVERNMENT
II. By size of system:
A. Large
State administration
Local administration
B. Medium
C. Small
Total
67.2
14.5
7.7
1.7
3.6
5.5
100
52.3
21.1
5.6
2.1
2.4
5.6
10.8
100
50.7
27.3
5.2
1.2
1.7
5.2
8.5
100
55.4
16.2
6.1
3.0
3.0
6.1
10.0
100
84.4
2.3
1.6
1.1
1.1
1.1
8.2
100
84,6
2.0
.7
12.6
100
84.1
3.2
.6
1.0
.3
1.0
9.8
100
Note: Table relates to question 6.
TABLE 5.— NUMBER OF EMPLOYERS CONTRIBUTING TO RETIREMENT SYSTEM
System category
Percent of plans
1
2
3 to 5
6 to 10
11 to 15
16 to 50
51 or more
Total
58. 2
1.8
5.4 .
3.6
5.5
25.5
100
58.7
4.9
7.4
4.1
.3
4.3
20.4
100
91.9
3.1
3.7
1.3
100
97.2
2.1
.7 .
100
93.5
2.5
1.7
.5
.3
1.5
100
I. Federal Government...
STATE AND LOCAL
GOVERNMENT
II. By size of system:
A. Large..
B. Medium
C. Small..
Total...
'The percentage unknown is 6 percent of plans in the large strata, 3.3 percent of plans in the medium strata, and
1.4 percent of plans in the small strata.
Note: Table relates to question 7i
74-365—78 14
204
TABLE 6.— ACCOUNTING TREATMENT OF RETIREMENT SYSTEM ASSETS, LIABILITIES, RECEIPTS, AND
DISBURSEMENTS
System category— number of contributing
employers
Accounting
on a planwide
basis only
Percent of plans 2
Separate
accounting
for each
employer
Separate
accounting
for each
employer;
assets
allocated
so as not to
pay benefits
to employees
of othe r
employers
Total
I. Federal Government:
1
More than 1
Total
STATE AND LOCAL GOVERNMENT
II. By size of system:
A. Large:
1
More than 1
Total
B. Medium:
1
More than 1
Total
C. Small:
1
More than 1
Total
III. State and local totals:
1
More than 1
Total 97.5 1.1 1.4 100.0
58.2
21.8
fi
0)
10.9
58.2
41.8
80.0
9.1
10.9
100.0
58.7
26.1
O)
6.0
0)
9.2
58.7
41.3
84.8
6.0
9.2
100.0
91.9
2.7
O)
4.2
ft
91.9
8.1
94.6
4.2
1.2
100.0
97.2
2.1
(»>
0)
.7
97.2
2.8
99.3
.7
100.0
93.5
4.0
ft
05
1.4
93.5
6.5
1 Not applicable.
2 The percentage unknown is 6 percent of plans in the large strata, 3.3 percent of plans in the medium stra'
and 1.4 percent of plans in the small strata.
Note: Table relates to questions 8 and 9,
205
TABLE 7— RETIREMENT SYSTEM ADMINISTRATION
(percent of plans)1
System category
Retire-
ment
board or
board of
trustees
(only)
Ultimate policy and administration authority vested in
Invest-
ment
board
and/or
other
official
body
(only)
Retire-
ment
board
and sep-
arate in-
vestment
board
Retire-
ment
board
and other
official
body
Total
Plans having
Retire-
ment
board
Invest-
ment
board
I. Federal Government 25.5 56.4 7.3 10.9 100 43.7 9.1
STATE AND LOCAL GOVERNMENT
II. By size of system:
A. Large. 64.8
B. Medium 55.3
C. Small.... 52.3
III. By level of administration:
A. State administration 32.5
B. Local administration 56.2
IV. State and local total 53.7 32.1 2.0 12.3 100 67.9 2.1
11.5
21.8
36.0
33.4
31.8
9.6
5.0
.7
11.1
1.0
14.1
17.9
11.0
23.0
11.0
100
100
100
100
100
88.5
78.2
64.0
66.6
68.2
10.1
5.6
.7
11.7
1.1
!The percentage unknown is 1.1 percent of plans in the large strata, 1.6 percent of plans in the medium strata, and
4.9 percent of plans in the small strata.
Note: Table relates to question 10.
206
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TABLE 26— RETIREMENT SYSTEM PROVISIONS FOR A MINIMUM BENEFIT GUARANTEE AND FOR A MAXIMUM
BENEFIT LIMIT
(Percent of plans]
Minimum benefit guarantee Maximum benefit limit
Having No Having No
pro- pro- Un- pro- pro- Un-
System category vision vision known Total vision vision known Total
I. Federal Government 16.4 76.4 7.3 100 54.5 38.2 7.3 100
STATE AND LOCAL GOVERNMENT
By size of system:
A. Large
39.6
55.1
5.3
100
45.9
50.7
3.4
100
B. Medium
34.1
59.9
6.0
100
40.1
55.5
4.4
100
C. Small
51.7
35.7
12.6
100
50.3
38.5
11.2
100
. By level of administration:
A. State administration
20.1
75.0
4.9
100
23.3
72.0
4.7
100
B. Local administration.. . ...
51.4
36.8
11.8
100
51.4
38.4
10.2
100
Additional breakout of system coverage
categories included in police and fire
below:
A. Volunteer fire..
76.9
19.3
3.8
100
77.0
15.3
7.7
100
By social security coverage:
A. Covered systems
39.1
51.4
9.5
100
29.7
61.4
8.9
100
B. Systems not covered
57.4
30.0
12.6
100
67.5
22.2
10.3
100
State and local totals by system coverage
type:
A. State and local government
35.3
58.0
6.7
100
31.5
60.9
7.6
100
B. Police and fire
56.2
30.6
13.2
100
59.0
30.3
10.7
100
C. Teachers
50.2
47.7
2.1
100
31.0
66.9
2.1
100
D. Teachers (higher education)
10.4
83.3
6.3
100
2.7
91.0
6.3
100
Total
48.2
40.7
11.1
100
48.5
41.9
9.6
100
Note: Table relate to question 37, items 3 and 4.
TABLE 27— RETIREMENT SYSTEM PROVISIONS FOR SERVICE CONNECTED TOTAL PERMANENT DISABILITY
(Percent of plans]
Service required
System category
1-7
yrs
8-12
yrs
13-18
yrs
19
yrs or
None
re-
more quired
No
plan
pro- Un-
vision known
I. Federal Government
STATE AND LOCAL GOVERNMENT
By size of system:
A. Large..
B. Medium...
C. Small
By level of administration:
A. State administration
B. Local administration
Additional breakout of system coverage
categories included in police and fire
below:
A. Volunteer fire
V. By social security coverage:
A. Covered systems
B. Systems not covered
Ill
IV
VI. State and local totals by system coverage
type:
A. State and local government 9. 3
B. Police and fire 7.4
C. Teachers 26.9
D. Teachers (higher education) 1. 0
Total.
7.8
6.8
1.8
22.8
.7
3.3
2.1
2.4
11.0
2.2
Total
. 12.7
3.6
1.8 .
47.3
25.5
9.1
100
11.9
9.5
2.1
69.4
5.8
1.3
100
9.3
6.0
3.3
2.2
73.1
6.0
100
7.0
2.1
2.1
61.5
18.9
8.4
100
6.1
5.5
1.6
.8
79.4
6.3
.4
100
7.9
3.0
2.4
.3
62.0
17.1
7.3
100
3.8 ...
50.1
23.1
23.0
1C0
8.3
4.8
2.3
.3
60.9
20.0
3.3
100
7.1
1.6
2.3
.4
66.9
12.0
9.9
100
54.9
23.9
2.5
100
64.7
14.6
8.8
100
33.1
4.1
2.1
100
98.0
.3 ..
100
63.9
16.0
6.6
100
Note: Table related to question 37, item 6.
245
TABLE 28.— RETIREMENT SYSTEM PROVISIONS FOR NONSERVICE-CONNECTED TOTAL PERMANENT DISABILITY
(Percent of plans]
System category
1-7
yrs
Service required
!-12
yrs
13-18
yrs
19
yrs or
more
None
re-
quired
No
plan
pro- Un-
vision known
Total
I. Federal Government
STATE AND LOCAL GOVERNMENT
II. By sizs of system:
A. Large.
B. Medium
C. Small.
II. By level of administration:
A. State administration
B. Local administration
J. Additional breakout of system coverage
categories included in police and fire
below:
A. Volunteer fire...
V. By social security coverage:
A. Covered systems
B. Systems not covered •_.
. 14.5
1.8 .
47. 3
23.6
12.7
100
27.4
27.4
10.3
29.0
4.7
1.1
100
13.7
13.2
9.3
1. 6 46. 7
13.7
1.6
100
9.1
2.8
2.8
37.8
36.4
11.2
100
10.7
10.6
1.9
70.6
5.2
.9
100
11.2
5.7
4.6
.3 34. 7
33.6
9.9
100
VI. State and local totals by system coverage
type:
A. State and local government
B. Police and frre
C. Teachers
D. Teachers (higher education)
Total.
. 3.8 .
9.0
. 13.3
7.2
5.2
3.2
5.4
.2
.4
23.1
45.6
31.2
50.1
30.1
31.1
23.0
4.6
13.5
100
100
100
13.0
14.0
8.0
.3
37.7
24.4
2.5
100
11.0
3.2
3.2
.3
34.0
35.8
12.4
100
33.1
35.2
10.9
16.6
4.1
100
1.7
1.3 .
96.4
.7 .
100
11.1
6.2
4.4
.3
38.5
30.7
9.0
100
Note: Table relates to question 37, item 7,
TABLE 29.— RETIREMENT SYSTEM PROVISIONS FOR SERVICE CONNECTED PARTIAL DISABILITY
(Percent of plans]
Service required
System category
1-7
yrs
-12
yrs
13-18
yrs
19
yrs or
more
No
None plan
re- pro- Un-
quired vision known
Total
100
I. Federal Government 3.6
STATE AND LOCAL GOVERNMENT
II. By size of system:
A. Large.
B. Medium.
C. Small
III. By level of administration:
A. State administration
B. Local administration
IV. Additional breakout of system coverage
categories included in police and fire
below:
A. Volunteer fire
V. By social security coverage:
A. Covered systems
B. Systems not covered
VI. State and local totals by system coverage
type:
A. State and local government 8
B. Police and fire 2. 4
C. Teachers.. 10.4
D. Teachers (higher education)
Total nr
2.1
.3
27. 3 60. 0
. 1
9.1
2.9
1.3
.3
20.3
70.7
4.5
100
.5
1.1
.5 30. 8
62.6
4.4
100
2.1
.7
27.3
55.2
14.7
100
1.5
.6
58.2
37.7
2.1
100
2.0
.9
.1 23. 7
59.8
13.6
100
3.8
26. 9
46.2
23.0
100
1.6
1.6
24.9
63.5
8.4
100
2.3
.2 29. 7
51.4
16.4
100
3.8
86.6
7.9
100
30.2
51.2
15.3
100
12.4
73.0
2.1
100
97.4
2.3 .
100
27.2
57. 5
12.4
100
Note: Table relates to question 37, item 8.
246
TABLE 30.— RETIREMENT SYSTEM PROVISIONS FOR NONSERVICE-CONNECTED PARTIAL DISABILITY
[Percent of plans]
System category
Service required
1-7 yrs 8-12 yrs 13-18 yrs
No plan
provi- Un-
None sion known
Total
I. Federal GovernmenL
STATE AND LOCAL GOVERNMENT
II. By size of system:
A. Large
B. Medium
C. Small
III. By level of administration:
A. State administration
B. Local administration
IV. Additional breakout of system coverage cate-
gories included in police and fire below:
A. Volunteer fire
V. By Social security coverage:
A. Covered systems
B. Systems not covered
VI. State and local totals by system coverage
type:
A. State and local government
B. Police and fire
C. Teachers
D. Teachers (higher education)
3.6
3.8
1.8
4.3
1.3
3.8
12.4
1.8
1.5
1.3
1.8
4.1
.7
25.5
60.0
2.5
15.6
10.4
97.0
86.6
61.2
73.1
2.3
Total.
1.5
73.2
10.3
10.9
8.2
17.6
14.0
100
5.8
3.2
.5
14.8
71.2
4.5
100
2.7
2.2
26.4
64.3
4.4
100
2.8
1.4
15.4
63.6
16.8
100
2.2
1.0
56.7
37.8
2.2
100
3.1
1.7
.1
12.4
67.3
15.4
100
11.5
57.9
26.8
100
20.9
66.8
8.6
100
13.0
61.7
19.5
100
100
100
100
100
IOC
Note: Table relates to question 37, item 9.
TABLE 31— RETIREMENT SYSTEM PROVISIONS FOR DISABILITY PAYMENT REDUCTIONS ON ACCOUNT OF SOCIAL
SECURITY OR WO R KM ENS COMPENSATION AND OTHER DISABILITY BENEFITS
[Percent of plans]
Social security or workmens
compensation
Other disability benefits
Having
No
Having
No
Un-
provi-
provi-
Un-
provi-
provi-
Total
System category
sion
sion
known
Total
sion
sion
known
Federal Government..
.. 16.4
72.7
10.9
100
18.2
72.7
9.1
100
STATE AND LOCAL GOVERNMENT
By size of system:
100
A. Large ..
36.7
59.6
3.7
100
8.2
87.1
4.7
B. Medium
20.3
75.8
3.8
100
2.7
92.9
4.4
100
C. Small
16.8
69.9
13.3
100
7.0
76.9
16.1
100
By level of administration:
3.2
100
A. State administration
12.5
84.6
2.8
100
3.2
93.6
B. Local administration
19.5
68.3
12.1
100
6.8
78.5
14.7
100
111,
IV. Additional breakout of system coverage
categories included in police and fire
below:
A. Volunteer fire
V. By Social security coverage:
A. Covered systems
B. Systems not covered
VI. Stste and local totals by system coverage
type:
A. State and local government
B. Police and fire
C. Teachers
D. Teachers (higher education)
3.8
69.4
26.8
100
73.2
26.8
100
21.1
70.3
8.6
100
5. 6 83. 3
11.1
100
16.4
69.9
13.7
100
7. 2 77. 0
15.8
100
Total.
6.4
15.3
78.3
100
4.7
84.6
10.7
100
16.8
69.8
13.4
100
7.5
76.8
15.7
100
20.8
77.2
2.1
100
6.2
91.7
2.1
100
4.0
94.3
1.7
100
1.7
96.7
1.6
100
18.7
70.1
11.2
100
6.4
80.1
13.5
100
Note: Table relates to question 37, items 10 and 11.
247
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APPENDIX II
U.S. HOUSE OF REPRESENTATIVES
SUBCOMMITTEE ON LABOR STANDARDS
PENSION TASK FORCE
SURVEY OF PUBLIC EMPLOYEE RETIREMENT SYSTEMS
L_
This questionnaire deals with various aspects of your
retirement system, membership, contributions, vesting,
benefits and financing. It may be necessary to obtain the
assistance of others in your organization or to contact
auditors, actuaries, insurance companies or other outside
sources to obtain the necessary information. This study is
of the utmost importance and we urge you to provide the
best available information.
Please be sure that you answer this questionnaire for the
retirement system indicated on the label above.
For your own convenience you may use pencil in filling
out this questionnaire. For our convenience we would like
to request that you print the answers which require a
textual reply. Most of the questions, however, can be
answered by checking the appropriate box. These boxes
contain numbers for coding purposes. The preferred
manner of responding is to simply place the check mark
over the number.
Example: [TJ
if
®
When you have completed the questionnaire, please retur
it in the enclosed postage-paid envelope to:
U.S. House of Representatives
Subcommittee on Labor Standards
Pension Task Force Survey
Room 112. Cannon House Office Building
Washington. D.C. 20515
DO NOT WRITE IN THIS BLOCK
STATE.
.PLAN.
COVERAGE.
IDENTIFICATION
1 . Please provide the official name of your retirement
system.
Administrator — Please provide the name, title,
address, and telephone number of the person within
your organization who is responsible for the daily
business of the system, (e.g.. secretary or treasurer
of the system, personnel director, town manager,
etc.).
(NAME)
(TITLE)
(MAILING ADDRESS)
(CITY)
(STATE)
(ZIP CODE)
(AREA CODE)
(TELEPHONE NUMBER)
3. Please provide the name, title, and telephone number
of the person to be contacted if further information
is required.
[~1 Check here if person is the same as in Question 2.
(NAME)
(TITLE)
(AREA CODE)
(TELEPHONE NUMBER)
PLEASE KEEP A COPY OF THIS QUESTIONNAIRE
IN CASE WE HAVE TO CONTACT YOU FOR FURTHER INFORMATION.
— 1 —
302
II. MEMBERSHIP AND GENERAL
CHARACTERISTICS
4. Throughout this questionnaire you will be asked to
provide data concerning your system. We would like
the data provided to reflect your situation on the last
day of the 12 month period on which the records of
your system are kept (e.g., plan year or fiscal year).
(Month) (Year)
5. Which of the following best describes the establish-
ment of your current system? (Check one and fill in
the blank.)
[T| A merger established the current system. The
last merger occurred in
(year)
[Tl This system withdrew from a larger system in
(year)
|T| Restructured old system and established a new-
one in
(year)
(T) Disbanded old system and created a new one in
(year)
[~S] This system has never merged with nor with-
drawn from another system. It was established
in
(year)
6. Have other systems or employee groups joined this
system? (Check one.)
|T| Yes. this last occurred in
(year)
\2\ No
7. Under your system, how many separate employers
contribute to the system?
Number of such employers
If there is more than one employer contributing to
the svstem answer Questions 8 and 9, otherwise GO
TO QUESTION 10.
8. Is separate accounting maintained for each employer
with respect to benefits, contributions, assets,
administrative expenses, etc?
LU Yes
[2] No
9. Are assets allocated to a particular employer used
only to provide benefit pavnunts to employees of
that employer (i.e., such assets may not be used to
provide for benefits to employees of other employers)?
LU Yes
[2] No
10. How is your retirement system administered? (i.e..
who has the ultimate authority to set retirement
policy, determine eligibility for benefits, set invest-
ment policv. carry out investment policy, etc.) (Check
all that apply.)
[T] Retirement board or board of trustees
[T] Investment board other than in [T]
[T] Other (please specify) .
11. Listed below are a number of categories of individuals who may be members of the board or other body
administering vour system. For each indicate.
[ 1 ] the number w ho serve on the board
[2j how they attained membership on the board
ID
Number of
Members
121
Membership Attained By
(Check Those Which Apply)
Nominated or Elected
by Plan Members-1
Appointed-2
Other- 3
1 1 1 Plan member (other than belowl
(2) Elected government official
(3) Other government official
141 Person outside government in investment, banking, finance field
(5) Other persons outside government
(61 Total board members
303
12. Who is the custodian of the assets of the plan? (Check
all that apply.)
[71 Treasurer of related governmental body
|~2~] Retirement board or board of trustees (collectively)
PI Individual board member
|7| Administrator of system
IT] Investment advisor or broker
[b] Bank or trust company
[T\ Insurance company
f~8~] Other (please specif} )
13. Which statement best describes the extent to which
your system is affected by collective bargaining?
(Check one.)
|T] Not affected by collective bargaining at all
1~2~1 For at least some employees, benefit levels and
or employer contributions are affected by
collective bargaining subject to final approval
by legislature, board of trustees, referendum,
council, etc.
|~3~1 For at least some employees, benefit levels are
set solely by collective bargaining
[~4~| For at least some employees, contribution levels
are set soiely by collective bargaining
|~5~1 For at least some employees, benefit levels and
employer contributions are set solely by collective
bargaining
["6~1 Other (please specify)
14. Which statement best describes the extent to which
your retirement system is audited? (Check all that
apply and fill in the blank.)
\T\ Not audited
[T\ Audit by agency of government every
year(s)
[J] Audit by licensed or certified accountant outside
government every year(s)
Rl Other (please specify)
15. Are members of the system furnished with a
summary plan "booklet" describing important plan
provisions? (Check one. )
(T) Yes. automatically
["2~! Yes. upon request
CD No
16. Are members furnished with written descriptions of
plan amendments? (Check one.)
[Tl Yes. automatically
HT| Yes. upon request
[T) No
17. Are members given statements of contributions?
(Check one.)
[T] Yes. automatically every year(s)
[~2~] Yes. upon request
CE) No
[Tl Not applicable, employees don't contribute
18. Are members given statements of accrued benefits
or data enabling benefit calculation? (Check one.)
[T] Yes. automatically every year(s)
[~2~1 Yes. upon request
El no
19. Some public retirement systems have applied for
qualified status under Section 401(a) of the Internal
Revenue Code and have received a determination
letter from the IRS. Which statement best describes
your situation?
|~1~1 Not familiar with the process discussed
[Tj Familiar with the process but have not applied
for qualified status
Explain:
m
[J] Received favorable IRS determination letter
dated (if readily available)
[4] Received unfavorable IRS determination letter
dated (if readily available)
|~5~1 Applied for initial determination but have not
received a determination letter
304
20. The information asked for in this question and others to follow may require assistance from others in your
organization or may have to be obtained from insurance companies or other sources. The best available
information is of the utmost importance.
For each of the employee categories listed below, indicate:
1 1] the number of currently active employees— full time (as defined by your system), part time and other,
and total — covered by your retirement system, and
(2] the number of those employees (listed in (1 ]) also covered by Social Security.
Give the information as of the most recent date available
(Month) (Year)
Employee (Member) Category
[1]
Number of Currently Active
Employees Covered by
Retirement System
[2]
Number of Currently Active
Employees also Covered
by Social Security
Full Time
Other
Total
Full Time
Other
Total
( 1 )
Federal employees
(2)
State employees (other than
specific categories listed below)
(3)
Local government employees—
of counties, cities, towns,
townships, etc. (other than
specific categories listed below)
(4)
Police
(5)
Fire
(6)
Police and fire (where combined)
(7)
Teachers (other than higher
education)
(8)
Faculty, teachers and other
professionals in higher
education
(9)
Other (please specify)
(10)
Other (please specify)
(1T) TOTAL
21. Select the employee category (numbered (1) — (10)) which
has the largest total number of currently active employees.
Indicate the category number and name here.
Number
Name
Throughout the remainder of the questionnaire this "BIGgest CATegory" will be called BIGCAT. Please
choose a "typical" employee in the "BIGCA T" category and answer the succeeding questions for this "typical"
employee when "BIGCA I is specified.
— 4 —
305
22. Listed below are various categories of former employees (members) and beneficiaries. Please indicate the
number of individuals in each category'- If at all possible, please provide the number of individuals in each
category; do not combine categories.
Number of Individuals
( 1 ) Retired employees (retired on age and
service only)
(2) Retired employees (disability only)
(3) Beneficiaries — persons receiving benefits
now (or on a deferred basis) as a result
of the death of an active or retired
member
(4) Terminated employees with vested benefits
(5) TOTAL
306
III. MEMBERSHIP REQUIREMENTS
23. For each of the employee (member) categories covered by your retirement system, indicate for a 'typical'
employee in each category
[1] the period of sen-ice which is currently required for an employee to become a member of the retirement
system.
[2] whether employees with less than full time permanent service (as defined by your system) are eligible for
membership in the system.
[3] the minimum number of hours per year which any employee must work to be eligible for membership in
the system (e.g., if 20 hours per week — specify 1040 hours).
[1]
Period of Service Required
[21
(Check One)
Less
Than Full
[3]
Minimum
Employee (Member) Category
No Minimum
Required
Less Than
1 Year
1 Year But Les:
Than 2 Years
2 Years But Le:
Than 3 Years
3 Years But Le:
Than 4 Years
4 Years But Le:
Than 5 Years
5 Years But Le:
Than 6 Years
6 Years or Mori
Time
Eligible?
(Check One)
Per
Year
(Specify)
Yes
No
(1) Federal employees
1
2
3
4
5
6
7
8
2.
(2) State employees (other than
specific categories listed below)
1
2
3
4
5
6
7
8
2
(3) Local government employees-
of counties, cities, towns,
townships, etc. (other than
specific categories listed below)
1
2
3
4
5
6
7
8
1
2
(4) Police
2
3
4
5
6
7
8
2
(5) Fire
1
2
3
4
5
6
7
8
1
2
(6) Police and Fire (where combined)
1
2
3
4
5
6
7
8
1
2
(7) Teachers (other than higher
education)
2
3
4
5
6
7
8
1
2
(8) Faculty, teachers and other
professionals in higher
education
1
2
3
4
5
6
7
8
2
(9) Other (please specify)
2
3
4
5
6
7
8
2
( 1 0) Other (please specify)
1
2
3
4
5
6
7
8
1
2
— 6 —
307
24. For each of the employee (member) categories covered by your retirement system, indicate | for a "typical"
employee in each category [ :
I * .
I - . " " { * j \ — — 4 | r- -
[ 1 ] the minimum age required to become a member of the retirement system .
[2] the maximum age, if any. at which an employee is barred from becoming a member of the retirement
system.
til
Minimum Age
(Check One)
[2]
Maximum Age
Employee (Member) Category
No Minimum Age
(Enter One)
21 Oir Less
22-25
26-30
Over 30
No
Maximum
(Check)
Specify
Age
( 1 ) Federal employees
1
2
3
4
5
1
(2) State employees (other than
specific categories listed below)
1
2
3
4
5
1
(3) Local government employees-
of counties, cities, towns,
townships, etc. (other than
specific categories listed below)
T,
3
4
5
1
(4) Police
2
3
4
5
1
(5) Fire
2
3
4
5
1
(6) Police and fire (where combined)
1
2
3
4
5
(7) Teachers (other than higher
education)
■■'4
2
3
4
5
1
(8) Faculty, teachers and other
professionals in higher
education
i
2
3
4
5
1
(9) Other (please specify)
1
2
3
4
5
(10) Other (please specify)
2
3
4
5
— 7 —
308
IV. CONTRIBUTIONS
25. Indicate below the percent of total system employees
which contribute to the retirement system in each of
the following ways.
(1 1 Make no contribution to the retirement system
(2) Make a mandatory contribution to the retirement
system*
(31 Make only a voluntary contribution to the retirement
lystem
Total
100
*For the purpose of this and other questions
"mandatory contributions" mean contributions
required to be made by the employee (e.g.. required
as a condition of employment, required in order to
receive any benefits from the system, or required to
be made for any other reason).
If some or all employees make mandatory contribu-
tions GO TO QUESTION 26 and continue; other-
wise. GO TO QUESTION 32.
26. For the largest employee group making mandator)
contributions indicate the method used to make
these contributions for a "typical" employee. (Check
one and fill in as appropriate.)
[Tj SINGLE RATE — The rate at which employees
contribute is % of compensation (earnings,
salary, etc.)
(T) STEP RATE — The rate at which employees
contribute is % of annual compensation
below S and %
(annual compensation)
above that limit.
[Tj ACTUARIALLY DETERMINED — The rate
at which employees contribute is actuarially
determined or otherwise varies by age. sex. or
length of service.
[JJ STEP RATE/ ACTUARIALLY DETERMINED
— The rate at which employees contribute is
X% of annual compensation below $
_and Y% above that limit.
(annual compensation)
The rate at which employees contribute is act-
uarially determined or otherwise varies bv age.
sex. or length of service.
[~5~] EXCESS — The rate at which employees contri-
bute is % of annual compensation in excess
of $ (currently.).
(annual compensation)
fol FLAT RATE — The rate at which employees
contribute is a fixed dollar amount of $
per annum.
27. Is there an upper limit on compensation (salary,
earnings, etc.) on which employees contribute?
(Check one.)
fT] Yes. a current maximum annual dollar limita-
tion of $
a no
28. Answer Questions 28-31 for the "typical" employer ;
in the employee category with the largest number of
currently active employees as indicated in Question
21 (referred to as BIGCAT).
For BIGCAT. does an employee forfeit all rights to
retirement benefits derived from employer contribu-
tions, if the employee withdraws his own mandatory
contributions after termination of employment (and
does not icdeposit any withdrawn contributions)?
(Check one.)
[D Yes
0 No
29. For BIGCAT. does your system have a "buy back"
provision whereby upon re-employment an employee
may redeposit contributions (including interest, if
any) previously withdrawn and restore prior service
credit? (Check one.)
CD Yes
H) No
30. For BIGCAT. indicate which of the following best
describes the rights of an employee with respect to
the return of his own mandatory contributions upon
termination of employment before retirement. (Check
one.)
(T) 100% of own mandatory contribution is return-
able without interest
[TJ 100% of own mandatory contribution is return-
able with interest
[Tj Part of own mandatorv contribution is return-
able with or without interest
fT) None of own mandator.' contribution is return-
able
31. For BIGCAT, is interest paid upon the return of an
employee's mandatory contribution?
fT) Yes. percent interest currently paid is %
EH No
309
V. VESTING
32. For each of the employee (member) categories covered by your retirement system complete the following con-
cerning vesting [for a •'typical" employee in each category"]
[ 1 ] Is there preretirement vesting?
Definition: For an employee who terminates employment before retirement and who does not withdraw
his own contributions (if any), vesting means the employee's right to receive a retirement
benefit at a later date based on all or part of the employer's contributions.
(// there is no preretirement vesting for each category, check "No" in the column below and GO TO
QUESTION 3b).
FOR THOSE CATEGORIES WITH PRERETIREMENT VESTING
[2| What is the minimum age that must be attafned for vesting (not age at which benefits start)?
- ENTER AGE OR. FOR NO MINIMUM —
[3] What is the minimum sen ice time (years) that must be served for vesting?
— ENTER NUMBER OF YEARS OR. "JT, FOR NO MINIMUM —
[4] Of the currently active employees (given in Question 20), how many have met the minimum age and
service requirements such that they would be eligible for vested benefits if they terminated?
Employee (Member) Category
[1]
Preretirement
Vesting?
[2]
Minimum
Age
[3]
Minimum
Service
[4]
Number of Vested
(Check One)
For
Time For
Vesting
(Yrs.)
Employees
(Specify)
Yes
No
Vesting
(1)
Federal employees
2
(2)
State employees (other than
specific categories listed below)
1
2
(3)
Local government employees—
of counties, cities, towns.
2
townships, etc. (other than
specific categories listed below)
(4)
Police
1
2
(5)
Fire
1
2
(6)
Police and fire (wtiere combined)
2
(7)
Teachers (other than higher
education)
2
(8)
Faculty, teachers and other
professionals in higher
education
2
(9)
Other (please specify)
2
(10)
Other (please specify)
2
(11)
TOTAL
310
33. For each of the employee (member) categories, please answer these additional questions on vesting.
[1] For the earliest point at which vesting is attainable, what is the percent of vesting achieved? That is, at
the earliest point vesting may be 100% (or full) or it may be partial or graded.
Example: After 5 years of service an employee may become 50% vested in his accrued benefits and
thereafter vesting is increased by 10% each year until 100% is achieved after 10 years. There-
fore, 50% vesting is achieved at the earliest point.
[2] What is the earliest age at which deferred vested benefits start without a reduction?
Employee (Member) Category
[1]
Percent Vesting
Achieved
At Earliest
Point
(Specify)
[2]
Earliest Age
For Payment
Of Deferred
Vested Benefits
(Specify)
( 1 ) Federal employees
(2) State employees (other than
specific categories listed below)
(3) Local government employees—
of counties, cities, towns,
townships, etc. (other than
specific categories listed below)
(4) Police
(5) Fire
(6) Police and fire (where combined)
(7) Teachers (other than higher
education)
(8) Faculty, teachers and other
professionals in higher
education
(9) Other (please specify)
( 1 0) Other (please specify)
-10-
311
34. For BIGCAT (the employee category with the largest
number of currently active employees) which of the
following best describes what service history is
required or allowed for an employee to become
vested? (Check one.)
fl~| An employee must be employed continuously
(without a "break in service", year after year) in
order to become vested.
f~7] An employee may be employed for a period of
time then may have a "break in service" of up to
prior to becoming vested and
(specify, e.g. 1 yr.)
must then be re-employed in order that both
periods of service be credited for vesting
purposes.
[~3~| An employee may have any number of "breaks
in service" of any length each as long as the sum
total service equals or exceeds the required
number of years for vesting.
35. For BIGCAT. is the period of service rendered prior
to membership (participation) in the system credited
for the purposes of meeting the vesting requirement?
(Check one.)
Q] Yes
(T) Membership is immediate, therefore, all service
is credited tow ard vesting.
[T] No
VI. BENEFITS
36. Are the benefits (retirement benefits, pre- and post-retirement death benefits and health benefits) the same for
all employee categories? (Check one.)
[T] Yes (or only have one employee category)
— when answering Question 37 you will, thus, be indicating the benefits for all employees in the system.
(D No
— when answering Question 37 give the benefits for a "typical" employee in the BIGCAT category.
312
37. Listed below are a number of benefits which may be provided under your system. For each one.
[1] indicate whether the benefit is provided (Check "Yes" or "No" in table)
[2] indicate whether the benefit is payable all or in part by coverage through an insurance company (Check
"Yes "or "No "in table)
[3] if there is an age requirement. ENTER THE AGE OR, FOR NO MINIMUM.
[4] if there is a service requirement, ENTER NUMBER OF YEARS OR. "jr. FOR NO MINIMUM.
—THIS APPLIES ONLY TO THE RETIREMENT SYSTEM NAMED ON THIS QUESTIONNAIRE AND
DOES NOT REFER TO OTHER PLANS AFFECTING THE EMPLOYEES.
[
Ber
Prov
(Chec
I
efit
ded?
k One)
[2]
All or Part
Covered By
Insurance?
(Check One)
[3]
Age
Requirement
(Specify)
[4]
Service
Requirement
(Specify)
Yes
No
Yes
No
RETIREMENT
NVVN
\ \\v
<^
\\\\
(1) Normal retirement (highest age)
2
1
2
(2) Optional normal retirement (lowest age
with no reduction in pension)
1
2
1
2
(3) Is there a minimum benefit guaranteed?
(e.g., dollar or percent)
2
1
2
ill
(4) Is there a maximum benefit limit?
(e.g., dollar or percent)
\ T1'
2
2
\\\\\\\\\\\\\\\\\
(5) Early retirement with actuarial or other
reduction in pension
2
1
2
Please continue . . .
DISABILITY
(6) Total permanent disability — service
connected
2
1
2
(7) Total permanent disability - non-service
connected
1
2
2
(8) Partial disability — service connected
1
2
2
(9) Partial disability - non-service connected
2
2
(10) Disability payment reduced by Social
Security or workman's compensation
1
2
1
2
(11) Disability payment reduced by other
disability benefits
2
2
— 12 —
313
37. (Continued)
Here are some additional benefits to consider.
[1
Benefit o
Provi
(Check
]
r Option
ded?
One)
[2]
All or Part
Covered By
Insurance7
(Check One)
Yes
No
Yes
No
PRE-RETIREMENT DEATH BENEFITS
-whether or not service connected
(12) Return of member's contribution (with or without
interest)
1
2
1
2
(13) Other lump sum payment
1
2
1
2
(14) Spouse survivor annuity
2
1
2
(15) Children survivor annuity
1
2
2
(16) Other dependent survivor annuity
1
2
1
2
POST-RETIREMENT DEATH BENEFITS
Optional modes of annuity payments (17—20)
(17) Joint and survivor annuity
1
2
1
2
(18) Annuity certain (payment for X years guaranteed)
1
2
2
(19) Modified cash refund (return of employee
contributions guaranteed)
1
2
1
2
(20) Other optional modes
2
1
7,
(21 ) Automatic survivor annuity (with no reduction to
employee's annuity)
2
1
2
(22) Other lump sum payment
1
2
1
2
Ju$t a few more . . .
HEALTH BENEFITS
(23) Preretirement hospital or medical
2
2
(24) Postretirement hospital or medical
2
OTHER PROVISIONS
^^^^^^
(25) Tax sheltered annuity available
2
2
(26) Provision for member borrowing (of own
contributions)
1
2
1
2
r
-13 —
314
.18. For BIGCAT. which statement best describes the
normal retirement benefit structure for that cate-
gory? (Check one.)
HI Defined benefit formula plan — law or system
defines formula for calculating the amount of
the benefit. (If so. GO TO QUESTION 39)
fTj Defined contribution plan (money purchase or
where benefits are based solely on accumulated
contributions and earnings). (If so. GO TO
QUESTION 42)
(TJ Plan benefits reflect both defined benefit and
defined contribution characteristics. (If so, GO
TO QUESTION 39)
39. For BIGCAT. indicate what employee compensation
(salary, earnings) is included in computing normal
retirement benefits? (Check all that apply.)
[Tj Base pay
(TJ Overtime pay
(T) Sick pay (for actual work absences)
(~4~| Unused sick leave
[Tj Longevity pay
[~6~| All other compensation or pay regardless of
reason for payment not listed above
TJ Other (please specify)
41. For BIGCAT, which of the following best describes
your system's formula used to determine normal
retirement benefits? (Check one and fill in blanks.)
—Please convert fractional amount to percent —
e.g.. 1 60 = 1.67%
(JJ FLAT PERCENT- percent of compensation
(Tj SIMPLE RATE- percent of compensation
times years of service
(T) VARIABLE RATE— percent of compensa-
tion for the first years of service plus per-
cent for the next years of service
[TJ STEP RATE— percent of compensation
below S (per annum) and
percent of earnings above it
[TJ EXCESS- percent of annual compensation
in excess of S (currently)
(~6~| OFFSET— percent of compensation offset
by percent of primary Social Security
benefits
[71 Other (please specif) I
!"8~| None of the above
40. For BIGCAT, over what length of time is compensa-
tion (salary , earnings) averaged in computing normal
retirement benefits? (Check one.)
(Tj Not based on compensation (not based on
employee's salary or earnings or salary in a
related job category) (GO TO QUESTION 42)
(Tj Based on last day's rate of compensation in job
category from which retired or related job
category.
(Tj 1 year or less
[Tj 2 years
|~S| 3 years
[Tj 4 years
UJ 5 years
[JJ 6-10 years
[Tj More than 10 years (but not career average)
jTo] Career average
42. For BIGCAT. indicate which statement(s) describes
the method by which benefits are adjusted for the
cost of living for the retired members. (Check all that
apply.)
[T| No adjustments have been made
[Tj Adjusted from time to time because of special
consideration by board, legislature or other body
[Tj Adjusted automatically with the cost of living
and w ithout limit
(TJ Adjusted automatically but subject to a limit
[Tj Adjusted by constant percent
Tj] Adjusted or based on active employee pay-
increases
[Tj Adjusted based on investment performance
["8~| Other (please specify)
315
43. Is there a constitutional or other legal provision
applicable to your entire retirement system prohibiting
the diminishment or impairment of benefits? (Check
one.)
CD Yes
(H No
|~3~| Don't know
44. Have retirement benefits (or other system features)
ever been curtailed or reduced for any part of your
entire system in the past ten years?
[E Yes
Please explain-
GO No
74-365 O - 78 - 21
316
45. For BIGCAT. calculate the total annual retirement benefit (single life annuity) for a "typical" retiring member
under the following conditions.
[ 1 ] Assume the employee is a male retiring on January 1 . 1976
[2] Calculate based on 65 years of age (If mandatory retirement age is earlier please specify age and
calculate benefits at this age instead.)
[3] If there is more than one benefit structure for BIGCAT use the most typical benefit structure
[4] Use the information as presented in the Income Table below
[5] If some wage categories in this question are inappropriate to your system enter "NA" (not applicable)
and use the wage category most applicable to the employees covered by your plan.
[6] Similarly, if a member retiring at age 65 cannot receive a benefit for one or more of the categories of
sears of service shown, then indicate "NA".
INCOME TABLE
Case 2
Year
Case 1
Case 3
Case 4
1975
S6.000
S8.400
S13.200
SI 8,000
74
5.715
8,000
12,570
17,145
73
5.440
7,620
11.975
16,325
72
5,185
7.255
11,405
15.550
71
4.935
6,910
10,860
14,810
1970
4.700
6.580
10.345
14,105
69
4.475
6.270
9,850
13,430
68
4,265
5,970
9,380
12.790
67
4,060
5.685
8.935
12.185
66
3,870
5,415
8,510
1 1 ,605
1965
3,685
5,155
8.105
1 1 ,050
Average
2 Year Average
S5.855
S8.200
S12.885
S17.570
3 Year Average
5,720
8,005
12,580
17,155
5 Year Average
5,455
7,635
12.000
16,365
10 Year Average
4,865
6.810
10,700
14.595
20 Year Average
3,985
5.580
8.770
1 1 .960
25 Year Average
3,650
5.110
8,030
10.950
30 Year Average
3,355
4,700
7,385
10.070
40 Year Average
2,870
4,020
6,320
8,615
Social Security Benefit
Annual benefit at age 65 53,013
S3.733
S 4,325
S 4,368
NOTE: Earnings prior to 1965 increase at 4% per annum.
Earnings from 1965 - 1975 increase at 5% per annum.
Years Of
Service
Completed
Total Annual Retirement Benefit
(Fill In)
Case 1
Case 2
Case 3
Case 4
10
S per yr.
S peryr.
S peryr.
S peryr.
20
25
30
40
— 16 —
317
VII. PORTABILITY
46. Which of the following are applicable to your system? (Check all those which apply.)
m
Employee automatically credited with service outside the system
IF SO. CHECK ONE. (T) Inside the State only
[T| Both inside and outside the State
m
Employee credited with service outside the system upon payment of an amount less than full actuarial
cost (e.g., employee contributions for such service)
IF SO. CHECK ONE. Q] Inside the State only
|~2] Both inside and outside the State
CD
Employee credited with service outside the system upon payment of full actuarial cost
IF SO, CHECK ONE. Q] Inside the State only
[~2| Both inside and outside the State
— n
3
Reciprocal agreement between public employers or systems to credit service without transfer of any funds
IF SO, CHECK ONE. [Tj Inside the State only
fT| Both inside and outside the State
(D
Reciprocal agreement between public employers of systems to credit service with transfer of funds
IF SO. CHECK ONE. (T) Inside the State only
[~2] Both inside and outside the State
in
Provision for crediting military service
0
Employee credited with all service with all employers participating in the system
(1
The system has provisions other than the above for crediting employees with service outside the system
®
None of the above
— 17 —
318
VIII. FINANCING
The information asked for in this section may
require the use of various reports from your files, the
assistance of others in your organization, or assistance
from your actuary, your auditor, your insurance
company or other sources. When necessary please
use these sources since the best available data is of
the utmost importance.
47. Are there any sources of financing the total retire-
ment system other than employee contributions at
any time? (Check one.)
[Q Yes (GO TO QUESTION 48)
Q] No (GO TO QUESTION 49)
48. Indicate below the sources of financing, other than
employee contributions.which apply to your system.
Employer contributions based on: (Check all that
apply.)
[T] General taxing authority without legal limitation
(T) General taxing authority with specific legal
limits
[~3] Special tax levied annually
[~4~] Special tax authorized and levied when required
[~5~] Other (please specify)
Miscellaneous sources of financing specifically ear-
marked for the retirement system. (Check all that
apply.)
(~6~| State subsidies
p7~| Investment income
[~8~1 Insurance premium taxes (e.g., fire, casualty,
etc.)
[~9~1 Traffic fines or court or parking meter revenues
(To) Charitable contributions
(TTJ Other (please specify)
49. What is the closing date of the 12 month period on
which the records of your system are kept (e.g., plan
year or fiscal year) for which you have the latest
information on your total system assets?
DATE:
(Month) (Day) (Year)
- 18 —
319
50. Give the following information for your retirement system for the 12 month period specified in Question 49.
Caution: Make sure that all data given is for the same 12 month period.
(1) Total system assets as carried on the system's "books" at the end of the 12 month period.
(2) Total system assets at market value (if available).
(3) Total system assets at cost (if available).
(4) Total system benefit payments made for the 12 month period.
(51 Total employer contributions for the 12 month period.
|6) Total employee mandatory contributions for the 12 month period.
(7) Total system investment income for the 12 month period.
(8) Total annual payroll of members covered by the system for the 12 month period.
51. For the total system assets at "book" value given in Question 50, #(1) above, check all of the following that apply.
Some or all assets are: JT] valued at cost
i~2~| valued at market
[Tj valued on an amortized basis
[Tl valued on some other basis
— 19 —
320
52. Are anv retirement benefits payable under your
system of the defined benefit formula type where the
law or system defines the formula for calculating the
amount of the benefit? (Check one.)
IT) Yes (GO TO QUESTION 53)
(T) No. all benefits are of the defined contribution
type (money purchase or where benefits are
based solely on accumulated contributions and
earnings) (GO TO QUESTION 61)
53. Which statement best describes the current method
of funding the retirement benefits under your
system? (Check one.)
[T1 Employer contributions are made on a basis
only sufficient to meet current benefit payments
(e.g., sometimes called pay-as-you-go) (GO TO
QUESTION 56)
|T] Employer contributions are made for each
member at the time of retirement in an amount
sufficient to fund all benefit liabilities (terminal
funding) (GO TO QUESTION 56)
(TJ All other funding methods not mentioned above
(e.g.. employer contributions are made to fund
pension benefits in advance of retirement on an
actuarial or other basis) (GO TO QUESTION
54)
54. Is the employer contribution to the system derived on
an actuarial basis? (Check one.)
[TJ Yes (GO TO QUESTION 55)
(TJ No (GO TO QUESTION 56)
55. Which actuarial method best describes the basis on
which your contributions are currently made? (Check
one.)
(TJ Actuarial method (e.g.. entry age normal, unit
credit) under which (1) normal cost (sometimes
called .current service cost) and (2) unfunded
"past service liability" is calculated.
If so. what is currently paid? (Check one.)
QJ Full normal cost
[TJ Less than full normal cost
And. what is done with the unfunded past
service liability? (Check one.)
[T] No unfunded past service liability or fully-
amortized
[~4~| Amortized over years
(TJ Frozen (interest only is paid)
[~6~1 Permitted to increase (less than the full
amount of interest is paid)
(~2~| Actuarial method under which unfunded "past
service liability" is not calculated. If so, check
one.
(TJ Full costs are paid under the aggregate
actuarial cost method
(TJ Full actuarial cost paid under other method
(T| Less than full actuarial cost paid
56. How often is an actuarial valuation made of your
system? (Check one. )
(TJ Has not been made in the last 10 years (GO TO
QUESTION 61)
[T] One or more have been made but not on any
scheduled time basis (GO TO QUESTION 57)
(T) It is done at least every (Check one. )
(JJ year
(TJ 2 years
|Tj 3 years
(TJ 4 years
[s] 5 years or more
(GO TO QUESTION 57)
321
This page is from the
SURVEY OF PUBLIC EMPLOYEE
RETIREMENT SYSTEMS
L
57. As of what date was the last actuarial valuation performed?
(Month) (Year)
58. What actuarial assumptions were used in the last actuarial valuation of your system9 (Check all that apply.)
PI Valuation interest rate of %
(T) Mortality table
(T) Disability table
[T| Other termination rates
[s\ Retirement rates which vary by age
|~6~] Single retirement age assumed
|T| Salary scale projection
f8~| Inflation was taken into account in the salary
scale at the rate of % per annum
If you are unable to supply the information requested in Questions 57-60 by using actuarial reports which you
have—
-PLEASE CONTACT YOUR ACTUARY BY TELEPHONE and ask if he can provide the information to you
over the phone so you can fill in the answers.
If this is not possible and you do have an actuarial report —
-PLEASE SEND A COPY OF THE RELEVANT SECTIONS FROM THE ACTUARIAL REPORT along
with the questionnaire when you return it.
If a report is not available—
-PLEASE DETACH ONLY THIS PAGE AND MAIL IT TO YOUR ACTUARY ASKING THAT THE
PAGE BE FILLED OUT AND RETURNED TO THE PENSION TASK FORCE AT THE FOLLOWING
ADDRESS: U.S. House of Representatives
Subcommittee on Labor Standards
Pension Task Force Survey
Room 112, Cannon House Office Building
Washington. D.C. 20515
If there are questions
call (202) 225-5494
-21-
322
59. Give the following information for the last actuarial valuation.
(1) Total value of system assets as used by the actuary in making actuarial computations
$
(2) Total system assets at market value (if not available, enter N/A)
$
(3) Total accumulated value of employee contributions made in the past by all presently
active employees (if not available, enter N/A)
Does this figure include interest accumulations as well?
(T) Yes (T) No
$
(4) Total system "reserve" (present value) for retired lives and all others currently receiving
benefits /
$
(5) Total system accrued liability (sometimes called "past service liability"; this figure should
include "prior service liabilities", if separately calculated). If "total system accrued
liability" is not calculated under the actuarial method for your system, enter N/A (not
applicable).
$
(6) Total system unfunded accrued liability (sometimes called "unfunded past service
liability"). If "total system unfunded accrued liability" is not calculated under the
actuarial method for your system, enter N/A (not applicable).
$
(7) Total system normal cost
a) total dollars
$
b) please calculate as a percentage of payroll
%
(8) Total annual contribution necessary to amortize (or pay interest on) unfunded system
liabilities shown in (6) above:
a) total dollars
$
b) please calculate as a percentage of payroll
%
These figures represent:
(T) interest only payment
[Tj amortization nf liabilities nuer ypari
60. For the total value of system assets as given in Question 59, 0(1) above. Check all of the following that apply.
Some or all assets are: (T) valued at cost
(T) valued at market
(T) valued on an amortized basis
f"4~| valued on some other basis
61. (T) Check here if you wish to receive a copy of the
results of this study.
Thank you for your cooperation. By completing and
returning this questionnaire you have made a major
contribution to the study of Public Employee Retirement
Systems.
22-
APPENDIX III
TECHNICAL NOTE ON THE METHODOLOGY USED IN THE
PENSION TASK FORCE SURVEY OF PUBLIC EMPLOYEE
RETIREMENT SYSTEMS
Prior to the initiation of the Pension Task Force study, the universe of public
employee retirement systems was unknown. ThQ 1972 Census of Governments
identified 2,304 pension plans covering state and local government employees.
This number was later found to represent about one-third of the total number of
state and local p^ns.
Under the direction of the Pension Task Force, the General Accounting Office
(GAO) and the Congressional Research Service (CRS) helped carry out the ex-
tensive effort that was needed to identify the remainder of the public pension
universe.
To obtain an inventory of the public plans in each state, the Pension Task
Force (PTF) requested the assistance of numerous officials and organizations.
With the assistance of plan administrators, public employee organizations, and
state retirement commissions, the PTF identified 6,630 plans maintained at the
state and local level and 68 federal plans (see Appendix IV). The efforts to identify
the universe, while extensive, were probably not exhaustive. The resulting under-
statement of total plans is believed to be less than 5 percent while the under-
statement of total membership is undoubtedly less than one-half cf 1 percent.
For sampling purposes the pension plans were organized into five strata as
shown below. In the Federal strata information on the 14 plans maintained by
the Federal Home Loan Banks was combined, thus reducing the total plans in
the Federal strata from 68 to 55.
Several groups of plans covering less than 1 percent of all state and local em-
ployees were excluded from the sample. The excluded groups include "closed"
plans and "supplemental" plans. Closed plans are plans which no longer accept
new members and which will phase out over time. Supplemental plans cover em-
ployees who are also covered under more basic retirement systems maintained
at the state and local level. In addition to the number of closed and supplemental
plans given in Appendix IV, the Bureau of the Census reports that pension bene-
fits are currently being paid under 124 or more closed plans in the state of Massa-
chusetts.
Information on the remainder of the excluded group of plans was insufficient or
unavailable at the time of sampling. One excluded group contains 314 defined
contribution plans administered by the ICMA Retirement Corporation covering
about 605 city and county managers. Also excluded were 62 Fireman's Relief
Association noncontributory plans maintained by 62 Kansas cities. Those plans
identified after the sample was chosen generally exhibit characteristics of the
sampled plans in the "small" strata.
The table below shows the number of plans in each strata, the number of plans
sampled in each strata, and the sample weight assigned to each sampled plan.
IDENTIFICATION OF PERS UNIVERSE
SAMPLING PROCEDURE
Strata
Number of
plans in
strata
Number of
plans
sampled
Sample
weight
Federal
State and local strata:
Legislative plans.
55
55
1.00
Small plans having less than 100 members..
Medium plans having 100 to 999 members..
Large plans having more than 999 members.
8
3, 999
778
379
8
180
194
379
1.00
27. 97
4.27
1.00
(323)
324
The sample sizes provide for a sampling error of about ± 5.6 percent with a 95
percent level of confidence assuming a 50-50 response split when sampling for
attributes. The actual sampling error for any single variable may vary. The sample
weights were calculated by dividing the number of responses in a strata into the
number of plans in the strata.
QUESTIONNAIRE DESIGN AND TESTING
Extensive efforts were made to ensure that the Pension Task Force survey
questionnaire would be readable and reliable, yet comprehensive. The review made
by various public pension groups of early questionnaire drafts proved helpful in
the design of the final product (see Appendix II for the survey questions and the
format of the survey questionnaire).
Questionnaire specialists with the General Accounting Office conducted an
extensive face-to-face pretest effort with plan representatives in the Pennsylvania,
Delaware, Virginia, Maryland, and Washington, D.C. areas. The questionnaire
was revised based on the pretest results, and the GAO produced the final instru-
ment for mailing.
MAILING AND RETURN OF QUESTIONNAIRES
Questionnaires were mailed to sampled plans during the period April 30 through
May 4, 1976. Follow-up letters were sent to non-respondents on June 4, 1976 and
June 25, 1976, and a mailgram was sent to non-respondents on July 9, 1976.
Extensive telephoning was made to non-respondents in an effort to increase the
response rate. Responses received after August 31, 1976 were excluded. Final
response rates by strata are summarized below.
Number of plans-
Strata
In sample
Responding
Response
rate
55
55
100.0
8
8
100.0
180
143
79.4
194
182
93.8
379
379
100.0
816
767
94. 0
Federal
State and local strata:
Legislative plans
Small plans having less than 100 members..
Medium plans having 100 to 999 members..
Large plans having more than 999 members.
Total .
MANUAL EDIT OF RESPONSES
Returned questionnaires were reviewed manually when they were received.
The review procedures covered the completeness of responses to selected ques-
tions which were considered "critical," the extent to which respondents followed
the instructions included in the questionnaire, and the extent to which responses
were legible. Telephone calls were made to plans whose responses were not
complete with respect to critical questions. Where incomplete, questionnaire
items were completed using information from financial and actuarial reports
when supplied. After completing the manual edit, the questionnaires were key-
punched to create a computerized data base.
MACHINE EDIT OF RESPONSES
The data base developed from the questionnaire responses was edited using
computer programs created specifically for that purpose. The data base was
edited to identify values termed "outlayers." Outlayers include (1) illegal values
for variables which can take on only certain values and (2) values which are two
standard deviations or more from the mean of a continuous variable. Identified
"outlayers" were traced to the original questionnaires for comparison, and the
data base was corrected as appropriate. A machine edit program was also used
to identify instances in which responses were given to questions which should
have been skipped by the respondent. The program corrected the invalid responses
by replacing the response with a value designated as a "missing value." Each
variable was tested to assure that any "missing values" were properly designated.
PROJECTIONS TO THE UNIVERSE
Each question response was given its appropriate sample weight when pro-
jections were made to the universe of public pension plans. The sample weights
for each separate strata are as shown above.
APPENDIX IV
NUMBER AND MEMBERSHIP OF PUBLIC EMPLOYEE
RETIREMENT SYSTEMS
The tabular data on the universe of public employee retirement
systems shown in this appendix finalizes the information presented in
the March 31, 1976 report of the Pension Task Force. In 1975 over
6,698 Federal, State, and local government retirement systems covered
about 15.4 million civilian and military employees.
As mentioned in the earlier report, the numbers shown do not in-
clude other arrangements, such as deferred compensation contracts and
"tax sheltered" annuities, which could also be characterized as pro-
grams to provide retirement income to various groups of public
employees.
Table I gives a summary of the membership of the 6,698 State and
local and 68 federal retirement systems which the Pension Task Force
has been able to identify to date. It is now believed that the under-
reporting of the total number of systems is less than 5%. Since only
the smallest towns and quasi-governmental jurisdictions remain un-
counted, the understatement of total membership is undoubtedly less
than Y2 of 1%.
The total plan count now includes 303 plans in Texas that were not
previously reported (principally plans covering employees of special
districts and fire departments). This propels Texas (with 398 plans)
ahead of Colorado (with 343 plans) among the top five states having
the largest number of public employee retirement systems.
Tables II and V present State and local PERS data by level of
administration and coverage class. A significant characteristic of the
PERS as shown in Table II is the fact that only 9.6% of all systems,
those which are administered on a statewide basis, cover 84% of the
active membership of all systems in the U.S. The footnotes following
Table VI form an integral part of the data presented and should not
be overlooked.
Tables III and IV show for each state the distribution of the sys-
tems and their membership by size of system. Significantly, the largest
systems, those with 1,000 or more active members, make up only 6.7%
of all systems, but cover 96.7% of the total active membership of all
public employee retirement systems.
Table VI shows the coverage and assets of the 68 systems maintained
by the federal government and related agencies and instrumentalities.
The membership of the 68 federally related systems makes up one-
third of the total active membership of the entire Federal, State, and
local PERS.
[The footnotes to all the tables appear on page 396.]
(325)
326
TABLE I —NUMBER AND MEMBERSHIP OF PUBLIC EMPLOYEE RETIREMENT SYSTEMS OF FEDERAL, STATE,
AND LOCAL GOVERNMENTS (FINAL), 1975
Membership (thousands)
Number of
Level of government plans Active1 Nonactive2 Total
State and local 6,630 10,397 2,347 12,744
Federal (uniformed services) 4 2,181 1,094 3,275
Federal (nonuniformed services) 64 2,839 3,402 6,241
Total „ 6,698 15,417 6,843 22,260
Note: Footnotes to all tables are presented on page 396.
327
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APPENDIX V
A Summary and Analysis of the Pension and Retirement
Systems for Employees of the 50 States and the District of
Columbia
(By Howard Zaritsky, Legislative Attorney, American Law Division)
Page
Alabama 398
Alaska 400
Arizona 401
Arkansas 402
California 404
Colorado 405
Connecticut 406
Delaware 407
District of Columbia ■ 407
Florida 408
Georgia 409
Hawaii 410
Idaho 410
Illinois 411
Indiana 413
Iowa 414
Kansas 415
Kentucky 416
Louisiana 417
Maine 417
Maryland 418
Massachusetts 419
Michigan 419
Minnesota 421
Mississippi 422
Missouri 423
Montana 424
Nebraska 425
Nevada 427
New Hampshire . 427
New Jersey 427
New Mexico 428
New York 429
North Carolina 429
North Dakota 430
Ohio 431
Oklahoma 432
Oregon 433
Pennsvlvania 433
Rhode Island 434
South Carolina 435
South Dakota 435
Tennessee 435
Texas 436
Utah 437
Vermont 438
Virginia 439
Washington , 439
West Virginia 441
Wisconsin 442
Wyoming 442
Summary of major State features 443
General Fiduciary Standards Applicable to Public Pension Plans in the
Fifty States 445
The Library of Congress,
Congressional Research Service,
Washington, D.C.,
(307)
398
Introduction
The pension and retirement plans for employees of the State and local govern-
ments have been the subject of substantial scrutiny in recent years. Although
these plans were excluded from most provisions of the Employee Retirement
Income Security Act of 1974 (ERISA),1 they were not ignored. The Congress
intended and planned a study of these plans to determine the extent to which
they could and should be regulated.2 Examination of some aspects of the plans in
each jurisdiction would appear an essential part of such a study.
This report will summarize and analyze the structures of retirement systems
for governmental employees of the ftfty States and the District of Columbia. It
will touch upon four aspects of these plans: structure, contributions, actuarial
funding, and State constitutional provisions.
(1) The discussion of plan structures will note each of the major pension and
retirement plans in the particular jurisdiction and, in general, the scope of the
plan's coverage, where not denoted in the name of the plan;
(2) The discussion of contributions will note whether or not the employees
participating in the particular plan must contribute towards the financing of
their pension benefits — i.e., whether the plan is contributory;
(3) The actuarial basis of funding for the plan will be noted where the statutes
designate such a basis. In determining that a plan is actuarially funded, no
evaluation of the assumptions or accuracy of the actuarial determinations will
be attempted. Rather, where a plan states that actuarial valuations will be made
to determine employer contributions (or, in some cases, employee contributions),
it will be presumed that the plan is actuarial. Similarly, where there are required
contributions for both current and past service costs, the plan will be considered
actuarially funded. Many plans fund on a flat percentage of employee salaries.
Where there is collateral evidence that this is actuarially determined, it will be
noted; but lack of such evidence does not necessarily mean that the funding is
not actuarial. It signifies, rather, that the statutes do not require actuarial funding;
(4) For each jurisdiction the provisions of the State constitution will be
examined, to the extent they explicitly deal with the general area of public pension
plans.
Case law, where relevant, and administrative interpretations published by
State Attorneys General will be noted and discussed. Each State will be discussed
in alphabetical order.
ALABAMA
There are three major public pension plans for employees of the State of
Alabama. Employees of local governments are not required to participate in
these plans, although they are permitted to do so at the locality's election.
The general pension plan for most employees of the State government of
Alabama is the Public Employees' Retirement System. This plan provides
mandatory coverage for all "regular employee (s) of the state of Alabama whose
salary is paid on a monthly basis by state warrant ..." except members of the
State legislature or individuals covered by the plan for Alabama's teachers. Ala.
Code, Title 55, section 456 et seq. Individuals covered by other State pension
plans and certain other persons are also excluded. Ala. Code, Title 55, section
456(2). Counties, cities, towns and public or quasi-public organizations may
elect to participate in the Public Employees' Retirement System by resolution
of the governing body. Ala. Code, Title 55, section 467(1). The system is funded
through both State (or local) and participant contributions. The participants
contribute through payroll deductions of 4 percent of "earnable compensation,"
generally, and 10 percent of earnable compensation for policepersons. Ala. Code,
Title 55, section 463. The State or local government, on the other hand, contributes
an actuarially determined set of contributions to fund the plan. Ala. Code, Title 55,
section 463.
The "peace officers" of the State of Alabama may participate in both the
Public Employees' Retirement System and the Alabama Peace Officers' Annuity
and Benefit Fund, which provides for additional retirement and disability bene-
fits. Ala. Code, Title 55, sections 475(44), 475(46), 475(47), 475(48), and 475(56).
The fund is open to all "peace officers," which includes individuals employed by
either the State of Alabama or a local governmental body, required by his/her
job to "give . . .full time to the preservation of public order and the protection
of life or property, or the detection of crime in the state. ..." The definition
' Public Law 93-400, 93d Con?., 2d Srss. (1974).
* See, e.g., H. Rept. No. 807, 93d Cong., 2d Sess. Sec. II-8 (1974).
399
I. also includes conservation law enforcement officers, fulltime coroners, but ex-
i eludes pardon, parole or probation officers, district attorneys, assistant district
i attorneys, assistant attorneys general, commissioners, deputy commissioners, or
municipal, county or State inspectors. Ala. Code, Title 55, section 475(37). To
f become a member, the peace officer will agree to contribute towards the funding
of the benefits $10 per month, plus an amount on initial application equal to
the $10 per month charge for the time between September 12, 1969 and the appli-
f. cation date, unless the officer continues to work as a peace officer and contribute
|; to the fund for the next 36 months. In this case, the initial application fee is
\i waived. Ala. Code, Title 55, section 475(44). The contributions by the govern-
| ment to the fund are fees added to the impositions upon conviction or acceptance
of a guilty plea from or of an individual for traffic offenses or criminal offenses
within the State. These penalty fines are used to fund the Alabama Peace Officers'
Annuity and Benefit Fund. Ala. Code, Title 55, section 475(45). While this is not
an actuarial system of contributions, the benefits are modulated to adjust for
actuarial valuation variations. If the value of the assets of the fund vary, the
benefits are similarly adjusted. Ala. Code, Title 55, section 475(49).
Teachers who may participate in the Alabama Teachers' Retirement System
are not eligible for the Public Employees' Retirement System, as noted earlier.
Supra., p. 3. However, if they meet the definition of "teacher" they are eligible for
the aforementioned Alabama Teachers' Retirement System. "Teacher" is de-
ll fined to include teachers, principals, superintendents, supervisors, college pro-
fessors, administrative officers, or clerks in the public schools or public colleges of
the State of Alabama. Ala. Code, Title 52, section 362. Membership of individuals
classified as "teachers" is mandatory. Ala. Code, Title 52, section 364. The system
is funded actuarially, with the teachers participating in the system contributing
4 percent of earnable compensation in the way of payroll deductions. Ala. Code,
Title 52, section 369. The State contributes an actuarially determined amount
yearty to fund the system. Id.
Although the three plans noted herein are the major public pension plans in the
State of Alabama, there is also a retirement fund for governors of the State and
former-governors, and their widows. The retirement benefits are funded directly
from the general treasury of the State and, therefore, are neither contributory nor
actuarial in nature. Ala. Code, Title 55, section 172(1), (2) .
Of historic and legal significance, although of no current impact, is the Fire
Fighters' Pension Fund. This fund was created by act of the Alabama legislature
in 1968, to provide benefits to firepersons. The fund was financed by a one percent
tax on premiums paid to insurance companies in the State of Alabama on all
policies of "fire, lightning, extended coverage, inland marine, and allied lines
and windstorm. . . ." 3 The tax, and consequently the pension S3rstem itself,
was struck down as unconstitutional by the Supreme Court of Alabama in Glasgow
v. Aetna Insurance Company. 4 After the decision of the court in Glasgow, the
State legislature enacted a similar statute to become effective only "upon the
adoption of an amendment to the Constitution of Alabama providing for a
pension fund for firefighters." 5 The amendment was never ratified by the voters,
who first rejected it on December 9, 1969.
The Alabama State Constitution generally prohibits the State legislature from
enacting "any law not applicable to all the counties in the State, regulating costs
and charges of courts, or fees, commissions or allowances of public officers. . . ."
Ala. State Constitution, Art. 4, section 96. Therefore, whenever a provision is
enacted regarding the pension and retirement plans of local governments, special
authorization must be made in the constitution of the State, or the law must be of
general applicability. The creation of the Public Employees' Retirement System
would be considered an example of a law of general application, whereas the special
laws regarding pensions for employees of Mobile County, which also exist, re-
quired explicit authorization in the State constitution. See Ala. State Constitution,
Amendments 150, 192.
3 See 223 So. 2d at 581.
* 284 Ala. 177, 223 So. 2d 581 (1969).
5 The court struck the act down on the basis that it violated the Fourteenth Amendment to the United
States Constitution by denying the insurance companies due process of law. The act provided that failure to
pay the tax would result in an automatic revocation of the company's license to do business in the State
with no mention or provision for notice or hearing. The court also noted that the measure was a revenue
measure, and should have been originated in the Alabama House of Delegates, rather than the State Senate.
This latter point, 
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